R1_M6: Employee Stock Options.
Employee Taxation:
(1). not taxable income as compensation [when granted or exercised]. (2). capital gain / loss when sold.
employee stock purchase plans. Employee Taxation:
(1). not taxable income as compensation [when granted or exercised]. (2). capital gain / loss when sold.
Nonqualified Options. If the option does not meet certain conditions described below for qualified stock options,it will be treated as a nonqualified option.
A nonqualified option is taxed when granted if the option has a readily ascertainable value at the time of the grant. Because nonqualified options often do not have an ascertainable value, the option is generally taxed when exercised.
Nonqualified Stock Option. Bob's adjusted basis in the stock is $3,200 [$2,400 exercise price + $800 recognized ordinary income]. The $2,400 exercise price is 200 shares x $12.
Bob has a long-term capital gain in Year 12 in the amount of $800. This is a selling price of $4,000 [200 shares x $20] less the adjusted basis of $3,200. Bob's employer can take a tax deduction in the amount of $800 in Year 10, the amount of ordinary income recognized by Bob.
Employer Taxation = No tax Deduction.
Generally, an employer does not receive a tax deduction for an ESPP because it is not considered compensation income to the employee.
Employer Taxation = no tax deduction.
Generally, an employer does not receive a tax deduction for an ISO because it is not considered compensation income to the employee.
Employer Taxation = Deduct expense in same year that employee reports income.
Generally, an employer may deduct the value of the stock option as a business expense in the same year that the employee is required to recognize the option as ordinary income.
Incentive Stock Option. Mary has a long-term capital gain in Year 12 in the amount of $16,000. This is a selling price of 40,000 [200 shares x $200] less the adjusted basis of $24,000. The holding period requirements have been met.
Mary also has an AMT preference item in Year 11 of $6,000. The FMV of stock on the date of exercise was $150, and the purchase price was $120. The excess is $30 x 200 shares. Mary's employer receives no deduction for the granting of the option.
Nonqualified Stock Option. On July 1, Year 10, Bob was granted a nonqualified stock option to purchase 200 shares of his employer's stock for $12 per share. This option was selling for $4 per share on an established exchange. Bob exercised these options on August 7, Year 11.
The stock was selling for $18 per share on the exercise date. On November 1, Year 12, Bob sold all of the share for $20 per share. Bob must report ordinary income in the amount of $800 [$4 x 200 shares] on the date of the grant in Year 10 because the option has a readily ascertainable market value.
Corporations may grant their employees the option to purchase stock in the corporation.
There are two types of employee stock options: nonqualified options and qualified options.
Incentive Stock Option. On July 1, Year 10, Mary was granted an incentive stock option [ISO] to purchase 200 shares of her employer's stock for $120 per share. The FMV of the stock on the date of grant was $120. Mary exercised these options on August 7, Year 11. The stock was selling
for $150 per share on the exercise date. On November 1, Year 12, Mary sold all of the shares for $200 per share. Mary does not recognize any ordinary income at the date of grant because this qualified as an ISO. Mary's adjusted basis in the stock is the exercise price of $24,000 [200 shares x $120].
Employee Taxation: Without Readily Ascertainable Value. ☐ if no readily ascertainable value exists, the taxable event is the exercise date, not the grant date. ☐ the holding period begins with the exercise date. ☐ if the options lapse, there are no tax consequences. ☐ on the date of exercise,
the employee recognizes ordinary income based on the fair market value of the stock purchased less amounts paid [if any] for the option. the basis of the stock is the actual exercise price plus any ordinary income recognized. Any future sale of the stock could result in a capital gain or loss.
Employee Taxation: ☐ Generally, if the option lapse, no deduction is available as the option was not taxed in the first place. There might be a loss if any amount was paid for the option itself.
☐ An employee may exercise up to $100,000 of ISOs in a year. Any amount exercised that exceeds this will be treated as a non-qualifying option. ☐ The excess of the FMV of the stock on the exercise date less the purchase price is a preference item for alternative minimum tax.
employee stock purchase plans. Employee Taxation: ☐ generally, there is no taxation of the option as compensation. The basis of the stock is the exercise price plus any amount paid for the option [if any].
☐ generally, any gain or loss on a subsequent sale of the stock is capital. if the holding period requirements are not satisfied, any gain is ordinary up to the amount that the stock's FMV on the exercise date exceeded the option price.
Employee Taxation: ☐ Generally, there is no taxation of the option as compensation. Basis of the stock is the exercise price plus any amount paid for the option [if any].
☐ generally, any gain or loss on a subsequent sale of the stock is capital. if the holding period requirements are not satisfied, any gain is ordinary, up to the amount that the stock's FMV on the exercise date exceeded the option price.
Employee Taxation: Readily Ascertainable Value= Taxable When Granted. ☐ there is no taxation on the date of exercise. The basis of the stock is the exercise price plus any amount previously taxed on the date of grant. Any future sale of the stock could result in a capital gain or loss.
☐ if the employee allows the options to lapse [not exercised], there is a capital loss based on the value of the options previously taxed.
employee stock purchase plans. Employee Taxation: ☐ Generally, if the option lapse, no deduction is available, as the option was not taxed in the first place. There might be a loss if any amount was paid for the option itself.
☐ if the option price is less than FMV of the stock on the grant date, then ordinary income is recognized as the lesser of the difference of the FMV of the stock when sold and the exercise price, or the difference between the exercise price and the FMV of the stock on the grant date.
Employee Taxation: Readily Ascertainable Value= Taxable When Granted. ☐ the holding period begins with the exercise date.
☐ if there is a readily ascertainable value, the employee recognizes ordinary income in that amount in the year granted. if there is a cost to the employee, then the ordinary income is the value of the option minus the cost.
employee stock purchase plans. Requirements: ☐ Generally, the plan must include all full-time employees other than highly compensated employees and those with less than two years employment. ☐ no employee can acquire the right to purchase more than $25,000 of stock per year.
☐ once exercised, the stock must be held at least two years after the grant date and at least one year after the exercise date. ☐ the employee must remain an employee of the corporation from the date the option is granted until three months before the options is exercised.
employee stock purchase plans. An ESPP may grant options to employees to purchase stock in the corporation. Requirements: ☐ the plan must be written and approved by the shareholders. ☐ the option cannot be exercised more than 27 months after the grant date.
☐ the option exercise price may not be less than the lesser of 85 percent of the FMV of the stock when granted or exercised. ☐ An ESPP cannot grant options to any employee who has more than 5 percent combined voting power of the corporation, parent, or subsidiary.
Definition of Readily Ascertainable Value = Taxable when granted. If the option is traded on an established market, it will have a readily ascertainable value. Otherwise, it will only have a readily ascertainable value if all of the following conditions are met:
☐ the option is transferable. ☐ the option is exercisable immediately in full when it is granted. ☐ there are no conditions or restrictions that would have a significant effort on the value. ☐ the fair value of the option privilege is readily ascertainable.
