Section 422
Also: Section 422, IRC 422, ISO rules
The IRC section that defines Incentive Stock Options and the conditions for preferential tax treatment, including the $100,000 annual vesting cap, 10-year term, employee-only eligibility, and holding period rules.
Section 422 is the statutory basis for Incentive Stock Options. The core rules are: options must be granted under a written plan approved by shareholders; the strike must be at least FMV on the grant date; the option term cannot exceed 10 years (five for 10% owners); the holder must be an employee through exercise, with a 90-day grace period; and the aggregate FMV of ISOs first becoming exercisable in any calendar year cannot exceed $100,000 per employee. Anything above that cap is treated as an NSO.
Example: a senior engineer receives 40,000 ISOs with a $10 strike on a four-year schedule. The first-year tranche of 10,000 shares has an exercise-starting FMV of $100,000, exactly at the cap. A second grant the same year of 5,000 ISOs would push $50,000 over the cap and that overage would be treated as NSOs.
Common mistake: assuming the $100,000 cap looks at exercise. It looks at first exercisability, meaning the vesting date.
Section 422 matters at grant structuring, at AMT planning, and at departure, where the 90-day rule controls whether ISO treatment survives.
Articles referencing Section 422
- ISO Exercise Strategy: When to Exercise, When to Hold, When to Walk
The three-way decision every ISO holder makes every year, broken down by strike price, spread, AMT exposure, and company stage.
- NSO vs ISO: When Each Comes Out Ahead for Tech Employees
The real tradeoff between non-qualified and incentive stock options, with after-tax comparisons across company stage, strike price, and holder tax bracket.