The purpose of this post is to discuss whether incentive stock option (“ISO“) awards should be designed to destroy ISO treatment with respect to terminated employees, thereby preserving the compensatory deduction to the corporation and increasing shareholder value.


  • ISOs are Favorable to Employees.  Generally, an option that is treated as an ISO is tax-favorable to employees because the optionee recognizes NO ordinary taxable income at the time of exercise (though the spread between the exercise price and the then fair market value of the underlying stock is an item of adjustment for AMT purposes), and any gain upon a later sale of the underlying shares would be captured at long-term capital gains rates if certain ISO qualification requirements, ISO employment requirements and ISO holding period requirements are satisfied.
  • ISOs Result in Lost Compensatory Deduction.  With respect to ISOs, no deduction is permitted by the corporation at the time the ISO is exercised.  In contrast, had the option been a non-statutory option (an “NSO“), then at the time the option is exercised the corporation would be entitled to a deduction equal to the spread between the exercise price and the fair market value of the underlying stock as of the date the option is exercised.
  • Post-Termination Exercise Period.  Of the many requirements for an option to maintain ISO treatment, one requirement is that the option must be exercised no later than three months following the date the optionee is no longer an employee of the corporation (or such lesser period if set forth in the option award agreement).

Idea to Preserve Shareholder Value – Inches Might Matter in the Aggregate

Consider whether it makes sense to design the ISO award agreement so that ISO status is maintained if the option is exercised while the optionee is an employee, and that ISO status is lost to the extent the option is exercised after the optionee’s employment is terminated (i.e., exercised by a terminated employee within the post-termination exercise period set forth in the option award agreement).   Supporting this from a shareholder policy perspective:

  • Shouldn’t ISO status be limited to only those optionees who continue to provide shareholder value on a post-exercise basis (i.e., only those optionees who remain employed with the corporation after the option is exercised)?
  • Shouldn’t the corporation capture the compensatory deduction under the premise that former employees provide no shareholder value?
  • Is this idea worth implementing given that an educated optionee would likely maintain ISO treatment by exercising his or her ISOs prior to terminating employment?

The answer is maybe (not all ideas are good ideas and not all ideas are practical).   If the foregoing were applied to situations where the optionee’s employment is being terminated by the corporation without Cause or by the optionee for Good Reason (i.e., situations that commonly trigger accelerated vesting), then the deductibility “win” could apply to the portion of the option that would have otherwise remained deductible after application of the $100,000 limitation of Section 422(d)(1) of the Code.  A win, but not much of a win since the $100,000 limitation eliminated ISO treatment with respect to a portion of the option.

In the end, the merits of this idea likely comes down to whether you believe tax minimization is a game of inches.  To that end, consider the philosophy set forth in Al Pacino’s inch-by-inch speech in the movie “Any Given Sunday,”.  To sum up the point of the speech, every inch matters.

As a follow-on to last month’s webinar, please join us this Thursday (July 11, 2019) for our FREE webinar entitled Multi-Disciplinary Facets to Net Withholding: It Ain’t Boring.   The purpose of this presentation is to discuss administrative and design considerations when effectuating net withholding with respect to equity awards, including whether to increase the net withholding rate from the minimum statutory rate (i.e., the supplemental rate) to the maximum individual rate.   Sign up at the above link if interested!

Please join us tomorrow morning at 10:00 Central for our free monthly webinar series.  Tomorrow’s topic, “Tips to Increase the Longevity of the Equity Plan’s Share Reserve,” will discuss ideas on how a publicly-traded company can lengthen the longevity of its equity plan’s share reserve, with the hopeful result of the company less frequently seeking shareholder approval to increase such share reserve.  More information can be found at the above hyperlink!

Just a quick reminder that this Thursday (March 14, 2019) we are hosting our monthly webinar program and the discussion topic is “Golden Parachutes & 280G: Design Pointers on How to Win.”  Our discussion will include: (i) an explanation of 280G and how the calculations are applied, (ii) how 280G issues are typically addressed in compensatory documents (discussed from both an employer and employee perspective), and (iii) a description of various mitigation techniques that an employer could implement to eliminate or greatly reduce the negative ramifications of 280G (i.e., eliminate or reduce the 20% excise tax to the employee and the disallowed deduction to the employer).  And as always, FREE continuing education credits may apply.

The purpose of this post is to highlight compensatory action items that publicly-traded issuers should consider this proxy season.  Such considerations include:

  • Chase the Say-on-Pay Vote.  The most common reason for a negative recommendation from ISS is a perceived pay-for-performance disconnect within the compensation structure.  Robust disclosure on this point can help, especially disclosure that clarifies why certain performance criteria were used and explains the degree of difficulty associated with achieving target performance.
  • Consider an Annual Equity Grant Policy.  Some issuers grant equity awards to executive officers based upon an initial dollar amount that is then converted into shares.  If such an issuer has a depressed stock price due to market volatility, then the conversion formula will result in the award having more shares (compared to the situation where the issuer’s stock price had not fallen).  Is the issuer ripe for an allegation that the executives are timing the market because equity was granted at a low stock price for the sole purpose of receiving a larger number of shares?  To help defend against such a question, issuers should consider having a documented annual equity grant policy.  The policy could be formal or informal (with the latter being clearly presented in the CD&A of the issuer’s proxy statement). Continue Reading Compensatory Action Items to Consider this Proxy Season

Employment agreements between publicly-traded issuers and their executive officers often contain severance pay provisions that are heavily negotiated at the time of entering into the agreements.  The purpose of this post is to consider whether the amount of contractually-provided severance pay could, over the employment term, be reduced proportionate to the increase in the executive’s wealth accumulation over the same time period (i.e., an inversely proportional relationship between the amount of severance pay and the amount of wealth accumulation by the executive over the employment term). Continue Reading Should Contractually-Provided Severance Pay Decrease as Wealth Accumulation Increases?

As we head into a new proxy season, we would like to invite you to attend our annual FREE webinar entitled “Upcoming Proxy Season: Compensatory Thoughts from ISS,” which will be held on Thursday, January 17, 2019 from 10:00 am to 11:00 am Central.  As always, continuation education credits are available.

For your convenience, our remaining 2019 monthly webinar program is as follows: Continue Reading Upcoming Proxy Season: Compensatory Thoughts from ISS

The recent settlement by James Dolan, CEO of Madison Square Garden Co. (MSG) serves as a reminder that the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR Act”) can apply to compensatory equity awards.  To avoid violations, a publicly-traded issuer should monitor (at least annually) equity grants and outstanding equity awards for ongoing HSR Act compliance.  To learn more, please see our Client Alert entitled “Not Just a Merger Issue – Compensatory Equity Awards Can Trigger HSR Filing Requirements.”

Continue Reading Reminder that Compensatory Equity Awards can Trigger HSR Requirements

If you interested in learning (or refreshing your skills on) how to negotiate executive employment contracts, then please tune in to our FREE 1-hour webinar on December 13, 2018, from 10:00 a.m. to 11:00 a.m. Central.  This webinar is entitled “How to Negotiate Executive Employment Agreements” and you can sign up here. Continue Reading How to Negotiate Executive Employment Contracts

Did you exercise (or are planning to exercise) an incentive stock option (“ISO”) during calendar year 2018?  Do you intend to sell the underlying stock within the 12-month period from the date you exercised the ISO?  If you answered yes to both of the foregoing questions, then as part of your tax planning, consider whether the underlying stock should be sold during calendar year 2018 in order to minimize your alternative minimum tax (“AMT”) exposure. Continue Reading ISOs: No Item of Adjustment for AMT Purposes if Exercise and Sell within Same Calendar Year