By Kampus ProductionYou might have heard the term ISO in companies offering compensation. Well, an incentive stock option (ISO) is a type of equity-based incentive compensation plan that provides an option to purchase shares of a company at a discounted price with the added benefit of tax savings. While the purpose of such incentives is to attract and retain employees in order to increase productivity, growth, and efficiency. However, compensation experts recommend that there is a limit to such plans because of the potential for abuse. In this regard, the ISO 100k limit rule states that it prevents employees from issuing more than $100,000 worth of exercisable options in a single plan year. In this article, we’ll discuss the concept of the ISO 100k limit rule and some ISO 100k limit clauses that help companies adhere to the same.ISO 100k limit and its clausesThe ISO 100k limit rule prohibits employees from issuing more than $100,000 worth of exercisable options in a single plan year. As per Internal Revenue Service (IRS) regulations, the ISO 100k limit rule must be applied during the plan year that follows the one in which the ISO was granted. Such a limit is applicable to maintain the plan’s integrity by preventing excessive issuance of options.To comply with the ISO 100k limit rule, companies can utilize the guidelines laid down by the IRS. Additionally, an organization must have an in-depth understanding of the ISO 100k limit clauses. This is because the key to a company’s compliance with the ISO 100k limit rule lies in these clauses. By utilizing such clauses, companies can be assured of their compliance with the ISO 100k limit rule. The clauses will be discussed in the later section of this article. But what is the ISO 100k limit?What is the ISO 100k limit?Before understanding the ISO 100k limit rule, knowing what an ISO is essential. An ISO is a type of stock-based incentive plan that provides employees with options to acquire stock at a discounted price. It usually offers flexibility to an employee in terms of the choice of a number of shares, the time frame provided for such stock acquisition, and other benefits. The ISO 100k limit rule is designed to put a cap on the value of stock options issued that should not be more than $100,000 per year.It is essential to note that this limit is applicable to the maximum dollar value of exercise only as the total number of shares issuable under a plan cannot be limited. Therefore, companies can ensure compliance with the ISO 100k limit rule by including the necessary ISO 100k limit clauses in their plan. This will help companies to issue options at a safe and reasonable level that satisfies the standards laid down by the IRS.What is the ISO 100k limit used for?The ISO 100k limit rule is created with the intention of protecting the interests of the shareholders. The purpose of this rule is to ensure that employees’ compensation is not deemed an excessive benefit, as it might attract penalties under certain scenarios. Furthermore, to minimize the level of dilution in the shareholders’ ownership, the ISO 100k limit rule helps maintain an equitable balance between the employees and owners by ensuring that the stock options issued are not excessive.The ISO 100k limit rule helps to ensure the maximum protection of all relevant stakeholders. It is essential to maintain proper communication between the company and its employees and shareholders to ensure that such a plan does not lead to any kind of legal or financial issues in the future. While understanding the ISO 100k limit clauses helps companies to ensure compliance with the applicable regulations and standards.Why should companies keep the ISO 100k limit rule?The ISO 100k limit rule helps to ensure that companies adhere to the regulatory and IRS standards by preventing employees from issuing excessive options. It is essential to note that it is illegal for an employee to issue more than $100,000 worth of stock options in a single year. Here are a few reasons why it is essential for companies to follow the ISO 100k limit rule:It is essential to have a safe and reasonable level of stock options issued to ensure an equitable proportion of the ownership in the company.To ensure the protection of all relevant stakeholders, including the employees, shareholders, and the business itself.It aims to prevent the abuse of tax benefits and avoid any kind of financial issues that can arise in the future.To ensure that companies comply with IRS standards, it is essential to understand ISO 100k limit clauses.A well-rounded plan is essential for a company in order to have successful and long-term growth. Issuance of excessive options can lead to additional dilution and threaten the overall stability of the plan.Vital ISO 100k limit clausesNow that we have understood the meaning of the ISO 100k limit rule and its implications, it is essential to understand the ISO 100k limit clauses. These clauses help companies ensure compliance with the applicable IRS and regulatory standards. Following are the five ISO clauses:1. Fair market value of the stock — Firstly, it is essential to understand the concept of fair market value. This refers to the price at which a share of stock can be purchased or sold. As such, it can be noted that there are no fixed values. If an employee chooses to exercise the options, a number of factors must be considered in determining the fair market value of a particular stock. While 409A valuation is a reliable means of determining the stock’s fair market value by considering the company’s various factors.2. Exercise for the first share — The ISO 100k limit rule can be complied with by ensuring that the first share issued to an employee is exercised under the provision of the ISO. This is because the IRS standards require employees to exercise their first share under the options plan. It will provide an employee with a valid reason for exercising their first share before they can exercise any other option.3. Vesting calculation — It is essential to determine whether or not the ISO 100k limit rule is being complied with in the event of any transfer of stock. The calculation of vested options can be done by multiplying the total number of shares issued with the stock’s fair market value (FMV). If the total value exceeds $100,000, then it can be assumed that the ISO 100k limit rule has been violated.4. Cliff vesting pitfalls — In the case of an employee whose ISO grant was maximized by the limit, the company might have inadvertently triggered non-qualified stock option (NSO) re-characterization. In this scenario, it is essential to note that the NSO grant is considered a separate grant in which the employee pays the difference between the grant and exercise prices.5. M&A acceleration pitfalls — The acceleration clause is one of the most significant clauses in the ISO 100k limit. When unvested shares become vested suddenly, it is considered an acceleration clause. Typically, this clause is double triggered because acceleration takes place when the second event, such as being laid off. It is common to see companies that the additional vesting to regular time-based vesting of shares. As a result, the employee might unknowingly trigger acceleration in the midst of a merger or acquisition.ISO 100k limit calculationIn this regard, you must be wondering how to calculate the ISO 100k limit and if you have violated it or not. Well, simply multiplying your option grants with the fair market value of each share is a good way to calculate ISO 100k limit. Now, let us look at the following example:1. Options granted — 120,000 shares2. Grant date — 3/1/20223. Vesting schedule — Monthly for four years with a one-year cliff4. Fair market value (FMV) — $2.50On 1st March of the year, the first year’s value of shares, or 30,000 options, can be exercisable based on the one-year vesting cliff date.For the next 36 months after the date of 1st March, the remaining shares will vest in equal sums each month, or 2,500 shares per month. While the rest of the nine months in the 2023 year, 22,500 more shares are exercisable. At a fair market value of $2.50 per share, the 52,500 shares that became exercisable in 2023 is $131,250, which ultimately exceeds the ISO limit of $100,000. Here is the year-wise calculation of the 100k ISO limit:· Year 2023Shares exercisable — 52,500Value exercisable — $131,250.00(Split Takes Place)· Year 2024Shares exercisable — 30,000Value exercisable — $75,000.00· Year 2025Shares exercisable — 30,000Value exercisable — $75,000.00· Year 2026Shares exercisable — 7,500Value exercisable — $18,750.00Now, this means that the total share exercisable is 120,000, and the total value exercisable is 300,000. Thus, you can see that to prevent breaching the $100k limit; ISO grants should be distributed over a number of years. Be sure to note that you can use the ISO 100k limit rule to comply with IRS and regulatory standards.ConclusionThe ISO 100k limit rule restricts employees from receiving more than $100,000 worth of shares in a year. It is common for options to be split into multiple grants in order to avoid exceeding the 100k limit. If an excess amount of stock options is exercised, the employee might trigger a number of consequences and pitfalls, including non-qualified stock options re-characterization, cliff vesting pitfalls, and acceleration clauses.Check out our new platform 👉 https://thecapital.io/https://twitter.com/thecapital_iohttps://medium.com/media/3b6b127891c5c8711ad105e61d6cc81f/hrefWhat are some vital ISO 100k limit clauses? was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.