Stock Options Howard Godfrey, Ph.D., CPA Professor of Accounting ©Howard Godfrey-2015

Refer to preceding slide. In what year does the employee first recognize income? 2012 How Much? $180 How much income is recognized when the stock is ultimately sold? $120

Stock Options Stock option is the right to buy a share of stock at a fixed price in a specified period of time or on a specified date. Options have three important dates Grant date: the date an employee gets the option. Exercise date: the date the employee trades the option for stock. Lapse date: when employee can sell and keep the proceeds Sale date: the date the employee sells the stock.

Stock Options There are two kinds of stock options –Nonqualified stock options Tax treatment depends on whether the option has a readily ascertainable fair market value –Incentive stock options No tax consequences until the sale date

Nonqualified Stock Options With Ascertainable FMV (Rare) At the grant date (assume no contingency) –Employee has ordinary income = FMV of option –Corporation has deduction = income recognized At the exercise date –Employee basis in the stock = exercise amount paid + income recognized –Holding period begins At the sale date –Employee has capital gain = sales price less basis

Nonqualified Stock Options With No Ascertainable FMV F At the grant date V No tax consequences F At the exercise date (assume stock vests here) V Employee has á Ordinary income = FMV of stock - exercise price paid, and á Basis in stock = exercise price paid + income á Holding period begins V Employer has deduction = income recognized F At the sale date V Employee has capital gain = sales price less basis

Nonqualified Stock Options Substantially Restricted F At the grant date - No consequences F At the exercise date V When restrictions lapse, employee has á Ordinary income = FMV - exercise price á Basis in the stock = exercise amount paid + income á Holding period begins V Employer has deduction = income F At the sale date V Employee has capital gain = sales price less basis F Consequences of grant and exercise date may be reversed with Sec. 83(b) election

Incentive Stock Options (ISO) Requirements for ISO treatment –Must be part of a qualified stock plan –Option must be exercised within ten years of date of grant –Option price must be > FMV of the stock at date of grant –Option cannot be transferable –FMV of the ISOs granted in a year cannot exceed $100,000

Incentive Stock Options Tax consequences –No consequences on grant or exercise dates (unless sold prematurely) –At the exercise date Employee has basis in stock = amount paid –At the sale date Employee has capital gain = sales price less basis (Cost) –Employer never has deduction

Stock Options Option – right to purchase stock at strike price for a specific time Grant date – date option offered to individual Exercise date – date option used to purchase stock Bargain element – difference between strike price and FMV of stock

Nonqualified Stock Options Employee recognizes ordinary income equal to the bargain element on the date the NQSO is exercised –Employer gets matching compensation deduction for bargain element –Employee’s basis for stock is cash paid + income recognized

Nonstatutory Stock Option Given nonstatutory option – 1 share at $100/share. [FMV is $100/share] Option exercised. Value is $150/share Buys 1 share at $100/share Sells stock for $300/share. For income tax purposes, the individual reports gain or $50 in Stock basis becomes $150. Gain of $150 in 2015.

Incentive stock option Given Incentive option for 1 share at $100/share. [FMV is $100/share] Option exercised. Value is $150/share Buys 1 share at $100/share Sells stock for $300/share. For income tax, the report no gain until Stock basis is $100. Gain is $200 in For AMT, recognize $50 as AMT adjustment in 2014 and stock basis for AMT becomes $150. Negative AMT adjustment to taxable income of $50 to get AMTI in 2015.