Future Business Leaders of America (FBLA) Entrepreneurship Practice Test

What is one of the requirements for incentive stock options?

1. The option must be transferable

2. The exercise price must be the fair market value of the stock at issuance

3. The employee must work for the company for a minimum of five years

4. Options can be exercised at any time

The correct answer is: The exercise price must be the fair market value of the stock at issuance

The requirement that the exercise price must be the fair market value of the stock at issuance is a fundamental aspect of incentive stock options (ISOs). This ensures that the stock options can provide a tax advantage for the employee. To qualify as an ISO under the Internal Revenue Code, the options must be granted with an exercise price that is at least equal to the fair market value (FMV) of the underlying stock at the time the options are granted. This arrangement not only aligns the interests of the employees with shareholders but also allows for favorable tax treatment, as employees can potentially defer taxes until they sell the stock. The adherence to this requirement is critical, as any deviation could disqualify the options from receiving ISO treatment. In contrast, other options listed do not align with the requirements set forth for ISOs. The option being transferable is generally not permitted in the case of ISOs, and although there are minimum holding periods, these are not specifics like the five-year requirement mentioned. The flexibility of exercising options at any time contradicts the structured timing typically associated with ISOs, which have specific guidelines regarding when they can be exercised.