RPA 2, Lesson 5
Under an incentive stock option (ISO), the stock option cannot be transferable and must be exercisable during the employee's ______ only by him or her.
(5.15) lifetime
What is the cash exercise method through which stock options can be exercised?
(5.16) An optionholder makes a cash exercise by paying the option price to the employer and having the stock transferred to him or her.
What are investment "leaps"?
(5.18) Leaps are long-term, publicly traded options.
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the risk-free ______ rate during the expected term of the option.
(5.20) interest
True or False: The actual value of stock options may never reach the fair value at grant.
(5.21) True
What is the income tax basis of a stock called?
(5.3) Option price
Nonstatutory employee stock compensation plans are not governed by any special provisions of the IRC; instead, they are interpreted under what two IRC Sections?
(5.9) IRC Sections 61 and 83
True or False: The expected life of an option may be shorter than the maximum option period in a plan.
(5.20) True
Aside from the AMT, an employee under an incentive stock option (ISO) is only taxed under what circumstance?
(5.3) An employee is taxed under an ISO when he or she sells the stock purchased under the option plan, and then any gain realized is taxed as a capital gain.
An employee stock purchase plan's option price cannot be less than the lower of what two amounts?
(5.6) An employee stock purchase plan's option price cannot be less than the lower of: 1. 85 percent of the stock's fair market value when the option is granted OR 2. 85 percent of the stock's fair market value when the option is exercised
True or False: Employee stock purchase plans can be discriminatory, meaning they can favor highly paid executives.
(5.6) False. Employee stock purchase plans are nondiscriminatory in that they cannot favor highly paid executives.
True or False: Employees who participate in an employee stock purchase plan agree to have an estimated amount withheld from their pay to provide the funds with which to exercise their options at the end of an option period.
(5.6) True
IRC Section 423 pertains to what five areas of employee stock purchase plans?
(5.7) 1. Eligibility 2. Exercise 3. Grants 4. Holding period 5. Shareholder approvals
An employee receives favorable tax treatment under an employee stock purchase plan if he or she does not dispose of stock within two years from grant of option and within one year from its exercise. What happens if the employee doesn't meet these requirements?
(5.7) The employee would be taxed on the difference between the fair market value of the stock and the option strike price when the option is exercised.
IRC Section 83 states that the fair market value of property transferred to a person for the performance of services shall be included in that person's ______ income in the first taxable year in which the person's rights in the property become transferable or are not subject to a substantial risk of forfeiture.
(5.9) gross
Which of the following Internal Revenue Code sections deals with taxation of property transferred in connection with the performance of services? A. Section 61 B. Section 83 C. Section 415 D. Section 422 E. Section 423
(5.0) B. Section 83
Nonqualified stock options (NQSO) are often granted with an option price equal to __ percent of the fair market value of the stock on the date of grant and for option terms of around 10 years.
(5.11) 100 percent
True or False: Parties establishing nonqualified stock options (NQSO) determine the terms, which are limited in the amount of stock subject to such options that are exercisable by an employee in any one year.
(5.11) False. Parties establishing nonqualified stock options (NQSO) determine the terms, which are NOT limited in the amount of stock subject to such options that are exercisable by an employee in any one year.
Which plan is more flexible for employees and employers: Employee stock purchase plan or nonqualified stock option (NQSO)?
(5.11) Nonqualified stock option (NQSO)
There generally are vesting requirements in stock option plans with periods for vesting ranging from __ to __ years.
(5.15) two to four
True or False: Employee stock options may need to be valued for estate planning.
(5.17) True
What is option price?
(5.3) Option price is the income tax basis of the stock.
All of the following statements regarding the valuation of employee stock options are correct EXCEPT: A. The options must be valued to the extent that employers financially recognize the cost of options when they vest. B. The options are not publicly traded and have no readily ascertainable market value. C. A well-known model for the valuation is the Black-Scholes option pricing model. D. Among several factors that comprise the calculation of an option are the option exercise price and the current price of the underlying stock. E. The intrinsic value of an option is the difference between the underlying stock's current market price and the option's expected dividend yield in perpetuity.
(5.0) E. The intrinsic value of an option is the difference between the underlying stock's current market price and the option's expected dividend yield in perpetuity. The intrinsic value of a stock option is the difference between the underlying stock's current market price and the option's strike price.
Which of the following statements regarding incentive stock option plans is (are) correct? I. They were created by the Economic Growth and Tax Relief Reconciliation Act of 2001. II. They may not discriminate in favor of highly compensated employees. III. Typically they are made available to employees with over five years of employment.
(5.0) None Incentive stock options plans were created in 1981 by the Economic Recovery Act, and they can be made available at the employer's discretion to only highly compensated executives.
Employee stock compensation plans can be divided at the highest level of classifications into what two types?
(5.1) Statutory plans and nonstatutory plans
IRC Section 83(b) provides that a person performing services (e.g., an employee) may elect within __ days of a transfer to include the fair market value of the transferred property in his or her gross income, even if the property is subject to a substantial risk of forfeiture or is not transferable and, hence, under Section 83 normally is not taxable at this point.
(5.10) 30
Nonqualified stock options (NQSO) are often granted with an option price equal to 100 percent of the fair market value of the stock on the date of grant and for option terms of around __ year(s).
(5.11) 10 years
What type of plan is a stock option that does not meet the requirements for ISOs and is taxed on the basis of the general revenue principles under Sections 61 and 83?
(5.11) Nonqualified stock options (NQSO)
What are nonqualified stock options (NQSO)?
(5.11) Nonqualified stock options (NQSO) are stock options that do not meet the requirements for ISOs and are taxed on the basis of the general revenue principles under Sections 61 and 83.
True or False: There are two-year and one-year holding periods for a nonqualified stock option (NQSO).
(5.12) False. No such holding periods exist.
Upon exercise of an option (and transfer of stock to the employee) under a nonqualified stock option (NQSO), an employee receives ordinary compensation income that is taxed based on regular federal income tax. What amount is taxed?
(5.12) The difference between the fair market value of the stock at exercise and the option price (the bargain element)
True or False: An employer receives a corporate income tax deduction for the amount of compensation income that the employee realizes at exercise of the option under a nonqualified stock option (NQSO).
(5.12) True
True or False: Gross income under a nonqualified stock option (NQSO) is not taxed at grant, because the tax regulations view their value then as not being readily ascertainable.
(5.12) True
Under a nonqualified stock option (NQSO), the employee's income tax basis in the stock is its fair market value at ______.
(5.12) exercise
What is a restricted stock plan?
(5.13) A restricted stock plan is an arrangement by which a corporation grants stock (or stock options) to an employee but where ownership of the stock is subject to a substantial risk of forfeiture.
Which plan can be part of a general compensation program or a bonus plan? A. Incentive stock option (ISO) B. Nonqualified stock option (NQSO) C. Nonstatutory employee stock purchase plan D. Restricted stock plan E. Statutory employee stock purchase plan
(5.13) D. Restricted stock plan
What type of plan is an arrangement by which a corporation grants stock (or stock options) to an employee but where ownership of the stock is subject to a substantial risk of forfeiture?
(5.13) Restricted stock plan
Which of the following plans abide by IRC Section 83 principles? I. Incentive stock option (ISO) II. Nonqualified stock options (NQSO) III. Restricted stock plan
(5.14) II. Nonqualified stock options (NQSO) III. Restricted stock plan
Which of the following plans provide an employer with a corporate income tax deduction when the employee receives gross compensation income? I. Employee stock purchase plan II. Nonqualified stock options (NQSO) III. Restricted stock plan
(5.14) II. Nonqualified stock options (NQSO) III. Restricted stock plan
Under which type of stock options plan is an employee's gross income measured by the fair market value of the stock at that time minus any cost to the employee?
(5.14) Restricted stock plan
True or False: Under a restricted stock plan, IRC Section 83 principles apply, meaning that an employee receives ordinary compensation income in the year the employee's rights to the stock are first not subject to the substantial risk of forfeiture or are transferable.
(5.14) True
Which of the following plans are transferable? I. Incentive stock option (ISO) II. Nonqualified stock options (NQSO) III. Restricted stock plan
(5.14, 15) III. Restricted stock plan
Are incentive stock options (ISO) transferable?
(5.15) No
Are nonqualified stock options (NQSO) transferable?
(5.15) No
Stock options can be exercised via one of what four methods?
(5.16) 1. Cash exercise 2. Cashless exercise 3. Reload options 4. Stock-for-stock exercise
What is the cashless exercise method through which stock options can be exercised?
(5.16) A a cashless exercise occurs when: 1. A stockholder buys the option stock from the corporation at the exercise price. 2. The stockholder sells enough stock to cover the purchase price plus commissions. 3. The stockholder delivers the remaining stock to the optionholder.
What is the reload options method through which stock options can be exercised?
(5.16) After an employee makes a stock-for-stock exercise, a reload option is available for the same number of shares used to pay the exercise price and is for the remainder of the option period of the underlying option that was exercised.
What is the stock-for-stock exercise method through which stock options can be exercised?
(5.16) An employee makes a stock-for-stock exercise by delivering owned shares of the employer's stock, which are equal in value to the option price, to the employer and having the option stock transferred to him or her.
Which exercise method occurs when an optionholder pays the option price to the employer and has the stock transferred to him or her?
(5.16) Cash exercise
Which exercise method occurs when a stockbroker buys the option stock from the corporation at the exercise price, sells enough stock in the open market to cover the purchase price plus his or her commissions and a small amount of margin loan interest and then delivers the remaining stock to the optionholder?
(5.16) Cashless exercise
Which exercise method occurs when an employee provides the employer the same number of shares used to pay the exercise price and is for the remainder of the option period of the underlying option that was exercised?
(5.16) Reload options
Which exercise method occurs when an employee delivers owned shares of the employer's stock, which are equal in value to the option price, to the employer and has the option stock transferred to him or her?
(5.16) Stock-for-stock exercise
True or False: Employee stock options are very different from publicly traded stock and other options.
(5.17) True
True or False: Employees may give up cash compensation in exchange for stock options.
(5.17) True
True or False: Investment "leaps" do not assist in the valuation of employee stock options.
(5.18) False. Investment "leaps" assist in the valuation of employee stock options due to their market premiums (prices).
What is the difference between the underlying stock's current market price and the option's strike price referred to as?
(5.19) The intrinsic value of a stock option
Define the term "intrinsic value" as it relates to stock options.
(5.19) The intrinsic value of a stock option is the difference between the underlying stock's current market price and the option's strike price.
One of the requirements a statutory compensation plan must meet to be considered an incentive stock option (ISO) is that the maximum value of stock for which an employee can exercise ISOs for the first time in a calendar year generally cannot exceed $__, valued at the date of grant.
(5.2) $100,000
One of the requirements a statutory compensation plan must meet to be considered an incentive stock option is that the term (i.e., duration) of an option cannot exceed __ year(s).
(5.2) 10 years
One of the requirements a statutory compensation plan must meet to be considered an incentive stock option is that an employee cannot dispose of the stock within __ year(s) from the granting of the option or within __ year(s) of the transfer of the stock to him or her.
(5.2) 2 years, 1 year
One of the requirements a statutory compensation plan must meet to be considered an incentive stock option is that the option price must be equal to or (greater than/less than) the value of the stock when the option was granted.
(5.2) greater than
One of the requirements a statutory compensation plan must meet to be considered an incentive stock option is that the option must be (nontransferable/transferable).
(5.2) nontransferable
Which of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is considered the most important?
(5.20) Expected volatility of the underlying stock's market price
Why is the expected volatility of the underlying stock's market price the most important factor used to determine the economic value of an option, according to the Black-Scholes model?
(5.20) The greater the volatility, the greater the option value will be.
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the expected ______ yield on the stock.
(5.20) dividend
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the option ______ price (i.e., strike price).
(5.20) exercise
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the expected ______ of an option. This is the time period for which the employee is actually expected to hold the option before exercising it.
(5.20) life
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the current ______ price of the underlying stock.
(5.20) market
One of the six factors that the Black-Scholes option pricing model uses to determine the economic value of an option is the expected ______ of the underlying stock's market price.
(5.20) volatility
True or False: The economic value (i.e., fair value) of stock options granted to employees can be substantial.
(5.21) True
The actual value of stock options may never reach the fair value at grant, and may even be __ if the actual market price of the underlying stock fails to rise from the option price or declines.
(5.21) zero
What planning technique may be used when an employer breaks ISO requirments to avoid an AMT problem?
(5.22) AMT neutralization
What occurs under an AMT neutralization?
(5.22) In an AMT neutralization, the employee sells enough ISO shares (after exercise) in disqualifying dispositions, so that his or her regular tax for the year becomes equal to his or her AMT; thus, there is not AMT to pay.
Breaking incentive stock option (ISO) requirements may be done to avoid an ______ problem or if the stock's price is expected to fall dramatically.
(5.22) alternative minimum tax (AMT)
Breaking incentive stock options (ISO) requirements may be done to avoid an AMT problem or if the stock's price is expected to (fall/rise) dramatically.
(5.22) fall
What is the difference between the fair market value of the stock at exercise and the option price called?
(5.3) Bargain element
What is the difference between the option price and the stock's fair market value on the date of sale called?
(5.3) Capital gain
What is capital gain?
(5.3) Capital gain is the difference between the option price and the stock's fair market value on the date of sale.
What is the main tax advantage of an incentive stock option (ISO)?
(5.3) The max tax advantage of ISOs is that there is no regular income tax levied at the grant or at the exercise of the option by the employee.
True or False: The alternative minimum tax (AMT) sets a limit on the amount that incentive stock option's (ISO) benefits can be used, to reduce total federal tax.
(5.3) True
An incentive stock option's (ISO) bargain element upon exercise of an ISO is an adjustment item for individual ______ (AMT) purposes.
(5.3) alternative minimum tax
The alternative minimum tax (AMT) applies to taxpayers who have certain types of income that receive ______ treatment or who qualify for certain deductions under federal law.
(5.3) favorable
True or False: An employer receives a corporate tax deduction when offering an incentive stock option (ISO), because the employee realizes gross compensation income from the plan.
(5.4) False. For an employer to get a corporate income tax deduction for compensation expense, the employee must realize gross compensation income from the stock plan. In the case of an ISO, since the employee never realizes compensation income, the employer never gets a corporate tax deduction.
Which of the following plans DO NOT provide an employer with a corporate income tax deduction when the employee receives gross compensation income? I. Employee stock purchase plan II. Incentive stock option (ISO) III. Restricted stock plan
(5.4, 8, 12) I. Employee stock purchase plan II. Incentive stock option (ISO)
What is an employee stock purchase plan?
(5.5) An employee stock purchase plan is an option arrangement under which full-time employees who meet certain eligibility requirements are allowed to buy stock in their employer corporation, usually at a discount.
What type of plan is an option arrangement under which full-time employees who meet certain eligibility requirements are allowed to buy stock in their employer corporation, usually at a discount?
(5.5) Employee stock purchase plan
An employee receives favorable tax treatment under an employee stock purchase plan if he or she does not dispose of stock within __ year(s) from grant of option and within __ year(s) from its exercise.
(5.7) two years, one year
What tax advantages are available to employers sponsoring employee stock purchase plans?
(5.8) None. Employers do not receive corporate income tax deductions at grant or exercise of options under employee stock purchase plans.
Which IRC Section defines gross income for federal income tax purposes for nonstatutory employee stock compensation plans?
(5.9) 61
Which IRC Section deals with taxation of property transferred in connection with the performance of services for nonstatutory employee stock compensation plans?
(5.9) 83
True or False: Statutory employee stock compensation plans are not governed by any special provisions of the IRC.
(5.9) False. Nonstatutory employee stock compensation plans are not governed by any special provisions of the IRC.