Accredited Wealth Management Advisor Practice Exam

What must occur after exercising incentive stock options to preserve their tax status?

1. Sell the shares immediately

2. Hold the shares for at least one year after exercise

3. Sell the shares before the end of the year

4. Transfer the shares to a trust

The correct answer is: Hold the shares for at least one year after exercise

To preserve the favorable tax treatment of incentive stock options (ISOs), it is essential to hold the shares for at least one year after exercising the options. This holding period is a key requirement for the gain from the sale of the shares to qualify for long-term capital gains treatment rather than being taxed as ordinary income. When ISOs are exercised, if the shares are sold before this one-year mark, the IRS considers it a "disqualifying disposition," and any gains realized will be taxed at the higher ordinary income tax rates instead of the lower long-term capital gains rates. This distinction underscores the importance of adhering to this holding requirement to maintain the tax benefits associated with ISOs. Other options, such as selling shares immediately or transferring them to a trust, can jeopardize this favorable tax status, as they do not meet the necessary criteria for long-term capital gains treatment. Therefore, understanding the significance of the holding period is critical for anyone seeking to maximize the tax advantages of exercising incentive stock options.