What is a Qualified Stock Option?

A qualified stock option confers special tax benefits on the employees of a corporation. This stock option is not reportable as taxable income to the employee at the time of grant, nor when the employee later exercises the option to buy stock. Once the employee eventually sells the stock, it is taxed as ordinary income; however, if he holds the stock for at least two years, it is taxable as a long-term capital gain. This type of option usually requires the recipient to either exercise or forfeit the option within 90 days of no longer being employed by the issuing company. A qualified stock option is not valid for tax purposes unless it follows the rules noted below:

Company ownership. Options cannot be granted to a person who owns more than ten percent of all classes of the employer’s stock, unless the maximum option term is restricted to five years and the exercise is at least 110% of the fair market value of the stock.
Employee only. A company can only issue incentive stock options to its employees, and those individuals must continue to be employed by the company until 90 days before the exercise date.
Maximum exercised. The maximum aggregate fair market value of stock bought through a qualified stock option exercise cannot exceed $100,000 in a calendar year. Any amount exercised in excess of $100,000 is treated as a nonqualified stock option.
Maximum term. The maximum term of a stock option is ten years.
Transfers. Options cannot be transferred by the recipient and they must be exercised during that person’s lifetime.