Do special rules determine when a leave of absence is a termination of employment for the purposes of ISOs?
Yes. For ISO purposes, a bona fide leave of absence greater than three months can constitute a termination of employment if you do not have a guaranteed contractual or statutory right to return to work after the leave. The ISOs become NQSOs if you do not have either of these (or if they expire under the grant's terms). The final IRS regulations on ISOs (August 2, 2004) confirmed that the Uniformed Services Employment & Re-Employment Rights Act of 1994 (USERRA) and the Family Medicare Leave Act (FMLA) are statutes that provide for these types of continued-employment rights.
Example: You are absent for more than three months but have a right under an employment contract, a union contract, or state or federal law to return to your job later. You are not treated as having terminated your employment for purposes of your ISOs. If no such right existed, you would be deemed to have ended your employment after three months of leave (i.e., on the 91st day of your leave). You would then have three months from this deemed employment termination date (or such shorter period as your option plan or grant agreement might specify) to exercise your ISOs.