Stock Options

Howard Godfrey, Ph.D., CPAProfessor of Accounting ©Howard Godfrey-2015

Value$300 $300 $300

ValuePer Share

$180 Value $180 $180Per Share

$150 $150 $150

ValuePer Share

$110 $110 $110

$100 $100

Cost Cost Cost Cost$100 $100 $100 $100

1/1/1999 1/1/2000 1/1/2001 1/1/2002Option is Option is Restrictions Stock

Granted at Exercised: Lapse is Sold$100/Share. Stock is when stock for $300

Purchased is worth per share.for $100. $180 per share.

Illustration: Nonstatutory (Nonqualified) Stock Options

$300 FMV $300

$180 FMV $180

$100 FMV $100

$0 $0

1/1/10 1/1/12 1/1/13Grant Vest Sold$100 $180 $300

Restricted Stock

Employee does not pay for it

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 OptionsStock 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 proceedsSale date: the date the employee sells the stock.

Stock OptionsThere 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

At the grant date No tax consequences

At the exercise date (assume stock vests here) Employee has

Ordinary income = FMV of stock - exercise price paid, andBasis in stock = exercise price paid + incomeHolding period begins

Employer has deduction = income recognizedAt the sale date

Employee has capital gain = sales price less basis

$9 FMV $9

$6 FMV $6

$5 FMV $5

$2 FMV $2Cost

$0 $2 $0

1/2/06 1/2/07 1/2/08 1/2/10Grant Exercise Lapse Sold

Value $2 $5 $6 $9

Stock Options- $2 Strike

Employee receives option to buy 100 sharesof employer stock at $2 per share.

No. Option FMV- FMV-

Information Date Shares Price Share Total

Receive option 1/2/06 100 $2 $2 $200 Exercise option 1/2/07 100 $2 $5 $500 Restrict. lapse 1/2/08 100 $2 $6 $600 Sell stock 1/2/10 100 $2 $9 $900 When restrictions lapse, stock is worth $400 more than her cost for the stock.Recognize income of $400. Sec. 83.

Non-qualified stock options

Nonqualified Stock Options Substantially Restricted

At the grant date - No consequencesAt the exercise date

When restrictions lapse, employee hasOrdinary income = FMV - exercise priceBasis in the stock = exercise amount paid + incomeHolding period begins

Employer has deduction = incomeAt the sale date

Employee has capital gain = sales price less basisConsequences 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 OptionsTax 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 OptionsOption – 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 1-1-2013. Given nonstatutory option –

1 share at $100/share. [FMV is $100/share]

1-1-2014. Option exercised. Value is $150/shareBuys 1 share at $100/share.

1-1-2015. Sells stock for $300/share.For income tax purposes, the individual reports gain or $50 in 2014. Stock basis becomes $150. Gain of $150 in 2015.

Incentive stock option1-1-2013. Given Incentive option for 1 share

at $100/share. [FMV is $100/share]

1-1-2014. Option exercised. Value is $150/share

Buys 1 share at $100/share.

1-1-2015. Sells stock for $300/share.

For income tax, the report no gain until 2015. Stock basis is $100. Gain is $200 in 2014.

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.

$9 FMV - $9 $9

$8 $8$7 FMV-$7 $7

$6 $6$5 FMV-$5 $5

$4 $4$3 FMV-$3 $3

$2 $2$1 $1$0 $0

Value 1/2/07 1/2/08 1/2/09 1/2/11per share $3 $5 $7 $9

Stock - Case 1,000 shares