Solving the ISO/NSO problem

Solving the ISO/NSO problem

Author: Vince Lo
Read time:  3 minutes
Published date:  May 3, 2021
Interpreting and tracking ISO/NSO splits is complicated. Carta and Orrick have partnered to solve it.

The US Internal Revenue Code imposes a limit known as the $100K rule, which prevents employees from treating more than $100,000 worth of options as incentive stock options (ISOs) within one year. Options that don’t fall within this limit are classified as non-qualified stock options (NSOs), which are subject to tax upon exercise and may be taxed at a higher rate after they’re exercised. 

The $100K rule can affect the amount of taxes a company needs to withhold. It can also impact how much employees owe in taxes, because ISOs can receive more favorable federal tax treatment.  

ISO/NSO splits can be complicated

Companies and their legal teams are responsible for interpreting and applying the specific ISO $100K rule as outlined in the IRC to make sure they’re properly bifurcating their options into ISOs and NSOs to meet the limit. Therefore, it’s important for companies and their legal teams to track where and how the rule gets applied to option grants. 

Interpreting and applying the $100K rule where complicated transactions and modifications are involved requires careful review and management by a firm like Orrick, whose team of experts takes a consistent, grounded, and detailed approach to ISO/NSO split analyses and management. That’s why Carta partnered with Orrick and collaborated closely to develop a default methodology for interpreting and tracking ISO/NSO splits.

“Carta’s $100K dashboard will empower any legal team to better track and manage complex ISO/NSO split scenarios on behalf of their clients.”—Christine McCarthy, Orrick

But different law firms have different approaches to keeping track of grants and applying the $100K rule. Historically, if a company or its legal counsel didn’t agree with the default estimate of the ISO/NSO split that Carta provided, the affected grants were canceled, split, and re-issued as separate ISO and NSO option grants. That made it very difficult to see how various grants contributed to the $100K calculation. The canceled and split grants also introduced downstream consequences for the company’s stock-based compensation accounting due to those extra cancellations and issuances. 

A new $100K dashboard on Carta

We recently launched a new dashboard to give you more transparency, flexibility, and data integrity around ISO/NSO splits. Now, you can clearly see how various grants are contributing to an optionee’s $100K ISO limit and capture when a legal team has a differing interpretation of the $100K rule from Carta’s default. Companies can also apply their legal counsel’s logic to ISO/NSO grants, eliminating the need to cancel and reissue grants.  

“The reports in Carta’s $100K dashboard will make calculating new issuances and modifications clearer, faster, and more accurate than ever before.”—Katherine Hogan, Orrick

Here’s how it works:

  • Transparency: Company administrators will have visibility into specific stakeholders and grants subject to the ISO 100K rule. Customers also gain access to a new report and data visualization of how each stakeholder’s ISO and ISO/NSO split grants contribute to their respective annual $100K limit.

  • Flexibility: Company administrators and their legal teams will have full control over their compliance needs with the ability to edit the default ISO/NSO split estimated by Carta. 

  • Data integrity: By using the grant editor in the dashboard, company administrators will be able to preserve the integrity of option grants and downstream expense accounting.

Find more information on Carta’s $100K dashboard here.

Author: Vince Lo
Vince is a product manager at Carta, solving complex equity management problems for our largest customers. Early in his career, Vince discovered the wealth-building characteristics of equity ownership, and now he's joined the cause to create more owners by building scalable equity management software at Carta. Outside of work, Vince can be found playing soccer, watching Formula 1 races, and hodling cryptocurrency.
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