Stock can be acquired through stock options in various ways:

1. Qualified incentive stock options

Qualified Incentive Stock Option Plans:

Incentive stock option plans are qualified if they meet the requirements of Internal Revenue Code Section 421. To qualify for this favorable type of option treatment, the options generally must be:

granted under a plan approved by shareholders;

exercisable only by the individual employee or his or her heir;

exercisable within ten years;

held for at least two years;

have an option exercise price no less than fair market value of the stock at the time of

the grant;

not held by an owner of more than ten percent of the voting power;

held by a person who is an employee of the corporation from the grant date until at least

three months before exercise (one year if disabled.)

In addition, the stock acquired must be held for at least one year after exercise of the option in order to receive favorable treatment. Your employer will be able to tell you if the options you have been granted meet these conditions.

The cost basis of the stock acquired is the exercise price paid for the shares of stock acquired by option (plus any compensation income recognized if there is a disqualifying disposition.)

The favorable treatment available for this type of option is that no income is recognized when the options are granted or exercised. Tax is owed only when the stock is sold. The tax owed depends on how long the stock was held after exercise of the option:

If the stock is held for at least one year after exercise of the option, the gain is a long-term capital gain.

If it is not held for one year. some or all of the gain is classified as compensation at ordinary income tax rates. The amount of compensation is the fair market value of the stock less the exercise price at the time of exercise of the option. The remainder of the gain is still eligible for capital gains treatment.

In either case. the difference between the exercise price and the fair market value at the date of exercise is added to gross income for alternative minimum tax (AMT) calculations. The cost basis for AMT purposes is increased by the same amount if the taxpayer is subject to AMT.

A final caution is that qualified incentive stock options that first become exercisable during any tax year are reclassified as non-qualified if the total fair market value of the stock exceeds $100,000.