Equity
The 10-Year Clock on Your Option Plan: When It Runs Out, Every ISO You Grant Is an NSO
Your option plan has its own 10-year expiry under Treas. Reg. 1.422-2(c). Grant an ISO after that date and it is really an NSO, taxed as wages at exercise.
By 409.AI Team - 2026-09-29
# The 10-Year Clock on Your Option Plan: When It Runs Out, Every ISO You Grant Is an NSO
A board meets in October 2026 and approves option grants for eleven new hires. The grant notices say "Incentive Stock Option." The plan document is the same one the company adopted at formation in 2016, amended twice since to add shares. Everybody signs. Nobody checks a date.
None of those eleven grants is an incentive stock option. The plan lost its power to grant ISOs eight months earlier, and no amount of paperwork saying otherwise changes what the options are or how they will be taxed.
This is one of the few equity mistakes that is both easy to make and impossible to unwind after the fact. It also does not appear on any cap table dashboard, because the date that matters is not a grant date or a vesting date. It is the date the plan itself was adopted.
Your equity plan runs two ten-year clocks, and only one of them is on the grant notice
Section 422 of the Internal Revenue Code sets out what an option has to be in order to qualify as an ISO. Two of those conditions are ten-year rules, and founders routinely collapse them into one.
The first is the one everyone knows. Under [IRC 422(b)(3)](https://www.law.cornell.edu/uscode/text/26/422), an ISO "by its terms is not exercisable after the expiration of 10 years from the date such option is granted." That is the option's own life. It is printed on the grant notice, it shows up in your ASC 718 expense model, and your equity software tracks it.
The second is the one nobody tracks. [IRC 422(b)(2)](https://www.law.cornell.edu/uscode/text/26/422) requires that the option be "granted within 10 years from the date such plan is adopted, or the date such plan is approved by the stockholders, whichever is earlier." The Treasury regulation repeats it in the same terms: [Treas. Reg. 1.422-2(c)](https://www.law.cornell.edu/cfr/text/26/1.422-2) says an ISO "must be granted within 10 years from the date that the plan under which it is granted is adopted or the date such plan is approved by the stockholders, whichever is earlier."
So the plan has an expiry date of its own, and it is measured from the plan's beginning, not from anything that happens to an individual grant. A company that adopted its plan in March 2016 can still have options outstanding in 2035 that are perfectly good ISOs. It cannot grant a new one in April 2026.
The window can close earlier than your plan document says
Here is the part that catches careful people.
An ISO plan has to be approved by stockholders "within 12 months before or after the date such plan is adopted" ([Treas. Reg. 1.422-2(b)(2)(i)](https://www.law.cornell.edu/cfr/text/26/1.422-2)). Before is allowed. In practice, plenty of companies have the stockholder written consent signed first and the board adoption resolution dated afterward, or the two land weeks apart in a formation package that nobody re-reads.
When approval comes first, the statutory clock starts on the approval date, because the statute measures from "whichever is earlier." Meanwhile the plan document usually contains its own termination provision, and that provision is very often drafted as ten years from adoption. If approval preceded adoption by six weeks, your plan document will tell you the plan is alive six weeks longer than the Code says it can grant ISOs.
The plan document does not get a vote on this. Grants made in that gap are not ISOs, however clearly the plan says the plan is still in effect.
Pull both dates now. The board consent adopting the plan, and the stockholder consent approving it. The earlier one, plus ten years, is your real deadline.
What a late "ISO" actually is
An option that misses a requirement of section 422(b) is not a defective ISO. It is a nonstatutory option, and it has been one since the moment it was granted.
The favorable treatment people associate with ISOs comes from section 421, and [IRC 421(a)](https://www.law.cornell.edu/uscode/text/26/421) applies only where "the requirements of section 422(a) or 423(a) are met." Where those requirements are not met, ordinary rules take over. The regulations make the handoff explicit: when an option fails ISO treatment, "the effects of such a transfer are determined under the rules of 1.83-7" ([Treas. Reg. 1.422-1](https://www.law.cornell.edu/cfr/text/26/1.422-1)).
Section 83 means the spread at exercise is compensation. The IRS states the rule plainly for nonstatutory options: you "must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option" ([IRS Topic No. 427](https://www.irs.gov/taxtopics/tc427)). For an employee that income is wages. It goes in boxes 1, 3 and 5 of the Form W-2 and is identified separately in box 12 under Code V, "Income from the exercise of nonstatutory stock option(s)" ([General Instructions for Forms W-2 and W-3](https://www.irs.gov/instructions/iw2w3)). Income tax withholding and payroll taxes come with it, and the withholding obligation is the company's, not the employee's.
There is no Form 3921 either, because [section 6039 reporting](https://409.ai/articles/form-3921-iso-exercise-reporting-section-6039) attaches to the exercise of an actual ISO. The absence of that form is often how a company finds out, usually in January, usually from a payroll provider asking why the numbers do not reconcile.
Running the numbers on one grant
Take an engineer who received 40,000 options in June 2026 at a $2.40 strike, the fair market value from a current [409A valuation](https://409.ai/products/409a). She exercises in 2029 when the fair market value is $9.00.
If the option were an ISO, she recognizes nothing for regular tax at exercise. The $264,000 spread is an adjustment item for alternative minimum tax, and if she holds long enough, the whole gain on an eventual sale is capital.
Because the plan's window had closed, it is an NSO. The $264,000 is wages in 2029. At a combined federal and state marginal rate of roughly 45 percent, that is about $119,000 of tax due in the year she exercises, before she has sold a share. Add Medicare on the company side and the employer's own payroll cost. Her basis resets to $9.00, so the tax she paid is not lost, but the timing is brutal, and she is paying it on stock she cannot sell.
The company does get something back. Denied a deduction on an ISO exercise under [IRC 421(a)(2)](https://www.law.cornell.edu/uscode/text/26/421), it now has a $264,000 compensation deduction under section 83(h). Founders rarely find this comforting when the engineer is in the room.
Multiply by eleven grants and the exposure is real, and it is the kind of thing that surfaces in diligence, not in a quiet quarter.
The good faith rule does not reach this
Section 422 has one good faith escape hatch, and it is narrow. [IRC 422(c)(1)](https://www.law.cornell.edu/uscode/text/26/422) says that where an option "would fail to qualify as an incentive stock option under subsection (b) because there was a failure in an attempt, made in good faith, to meet the requirement of subsection (b)(4), the requirement of subsection (b)(4) shall be considered to have been met."
Subsection (b)(4) is the pricing requirement, the one that says the strike cannot be below fair market value at grant. That is the requirement a defensible valuation protects, and it is the same reason [safe harbor status is about the appraiser and the method](https://409.ai/articles/409a-safe-harbor-price-vs-qualified-appraiser) rather than about the number itself.
The grant window is subsection (b)(2). No good faith rule covers it. There is no correction procedure, no election, and no version of the facts in which a board that meant well grants an ISO under an expired plan.
Compare that with the failures that do have a defined answer. The [$100,000 annual limit](https://409.ai/articles/iso-100k-limit-409a-grant-date-fair-market-value) under section 422(d) converts only the excess portion into an NSO and leaves the rest intact. A [post-termination exercise beyond three months](https://409.ai/articles/extending-post-termination-exercise-window-iso-nso-409a) converts that individual's options and nobody else's. An expired plan window converts everything granted after the date, for everyone.
What resets the clock, and what does not
Amendments are where the thinking usually goes wrong, because one kind of amendment genuinely is treated as a new plan.
[Treas. Reg. 1.422-2(b)(2)(iii)](https://www.law.cornell.edu/cfr/text/26/1.422-2) provides that "any increase in the maximum aggregate number of shares that may be issued under the plan (other than an increase merely reflecting a change in the number of outstanding shares, such as a stock dividend or stock split), or change in the designation of the employees (or class or classes of employees) eligible to receive options under the plan is considered the adoption of a new plan requiring stockholder approval within the prescribed 24-month period."
Read that carefully. It tells you a share increase triggers a fresh stockholder approval requirement. It does not say the ten-year grant window restarts, and the regulation offers no example working through what happens to the added shares. That question belongs to your counsel, on your specific plan and your specific amendment history, and it is not one to resolve by assumption in a board meeting.
Two things are clearer. An evergreen provision does not buy you time: [Treas. Reg. 1.422-2(b)(3)](https://www.law.cornell.edu/cfr/text/26/1.422-2) permits a plan to state its maximum with annual increases by specified percentages, but a share reserve that grows automatically is still a reserve under a plan that was adopted on one particular date. And a genuinely new plan, board-adopted with its own stockholder approval, has its own adoption date and therefore its own ten-year window. That is the ordinary fix, and it is routine when somebody notices in time.
Stockholder approval has to be real. Under [Treas. Reg. 1.422-3](https://www.law.cornell.edu/cfr/text/26/1.422-3), approval "must comply with all applicable provisions of the corporate charter, bylaws, and applicable State law," and absent a state law rule, by a majority of votes cast at a duly held meeting with a quorum present. A written consent circulated to the wrong list is not approval.
Before the date arrives
Find the two dates this week. Board adoption, stockholder approval, the earlier of the two, plus ten years. Put it in the same place you keep your 409A expiry, because it is the same kind of deadline: invisible until it bites, cheap to handle early.
If the date is close, the new plan needs to be adopted and approved before the next grant, not before the next board meeting. And because grants under a new plan are new grants, they need a current fair market value to price against, both for the [ISO pricing requirement](https://409.ai/articles/409a-valuation-frequency-how-often-should-you-get-one) in section 422(b)(4) and for the section 409A exemption that nonstatutory options rely on. Options and plan documents are among the [records that have to survive a cap table migration](https://409.ai/articles/cap-table-migration-records-checklist) intact, and the adoption date is the one people lose.
If the date has already passed, the grants made after it are NSOs. Say so now, price the withholding, and tell the people holding them what they actually hold. The worst version of this is the one where an employee finds out at exercise, having planned around a tax treatment that was never available.