A grant to a an employee to purchase stock at a discount at a future date.
What are the requirements for a grant to be an Incentive Stock Option?
The options must be under a plan approved by the shareholders that sets out the total number of shares and who may receive them.
The options must be granted within 10 years of the plan approval, and they must be exercisable within 10 years of being granted.
The exercise price may not be less than the FMV at the date of the grant.
The employee may not own >10% of the voting power of the entity for which the grant is made.
Once exercised the stock must be held at least 2 yrs after the grant date AND at least one year after the exercise date to be considered capital when sold, else it’s considered ordinary income when sold.
The employee must be an employee at the grant date, and the options must be exercised within 3 months of leaving employment.
An employee receives and then exercises a qualified Incentive Stock Option. What is the basis in the Option? How is it taxed?
Basis: Exercise price + amount paid for the option (if any)
Taxed When Sold:
++ Capital Gain/(Loss): If held at least 2 yrs after the grant date, and at least 1 year after the exercise date
++ Ordinary Gain/(Loss): If held less time than above
How does an Incentive Stock Option affect the Alternative Minimum Tax calculation?
FMV of the stock on the exercise date –purchase price (the exercise price) = AMT preference amount
True / False: The company receives a deduction for granting an Incentive Stock Option to its employee.
False
What are the requirements for a company to provide an Employee Stock Purchase Plan
The plan must be in writing and approved by the shareholders.
The employee cannot participate if he owns >5% of the voting power of the entity.
The employee cannot purchase more than $25,000 of stock per year.
Must include all employees who have been with the company >2 yrs, and who are not highly compensated
The option must be at least 85% of the FMV when granted or exercised
It must be exercised within 27 months after grant date
Once exercised the stock must be held at least 2 yrs after the grant date AND at least one year after the exercise date to be considered capital when sold, else it’s considered ordinary income when sold.
The employee must be an employee at the grant date, and the options must be exercised within 3 months of leaving employment.
An employee receives and then exercises a qualified Employee Stock Purchase Plan. What is the basis in the Option? How is it taxed?
Basis: Exercise price + amount paid for the option (if any)
Taxed When Sold:
++ Capital Gain/(Loss): If held at least 2 yrs after the grant date, and at least 1 year after the exercise date
++ Ordinary Gain/(Loss): If held less time than above
If the option price is less than the FMV of the stock on the grant date, then ordinary income is recognized as the lesser of
++ FMV on exercise date – option price OR
++ FMV on grant date – option price
What are nonqualified options?
Any option that doesn’t fit the definitions of qualified options (Incentive Stock Options or Employee Stock Purchase Plan)
What is the basis of the stock purchased using a nonqualified option? How are these stocks taxed when exercised? How are they taxed when sold?
The basis of the stock when exercised = purchase price + recognized gain.
The sale of the stock that makes up the option is separately taxed as capital gain/(loss).
How are nonqualified options taxed to the employee?
The option itself has value (not the stocks that make up the option, but the option itself).
If the option is readily tradeable on an options market, such that the value is easy to determine, then the option is taxed as ordinary income based on the value of that option minus any costs paid to obtain it. There is no tax on the exercise date b/c it was paid when received.
If the option lapses, a capital loss is taken based on the value previously taxed.
IF the option is not readily valuable, then the difference between the FMV on the date exercised and the exercise price becomes ordinary income.
Can the company deduct an amount for a nonqualified option?
Yes, the employer can deduct the value of the option (not the value of the stock that makes up the option) in the same year the employee recognizes ordinary income for receiving that option.
