Question

On March 1 of year 0, Judy was granted an incentive stock option (ISO) to purchase 50 shares of her employer’s stock for $10 per share. The FMV of the stock on the date of the grant was $12 per share. On May 1 of year 1, Judy exercised her option when the stock was selling for $15 per share. On July 1 of year 2, Judy sold all of the shares for $20 per share. What amount and character of income does Judy recognize in year 2?

$0

$500, ordinary

$500, long-term capital gain

$600, ordinary

Answer 1

Step 1: Granted on March 1 Year 0

50 Shares at the price of $10 per share

Step 2: Exercised on May 1 Year 1 for $15 per share. Judy has paid $500( for the shares worth $750) her base cost becomes $500. At this point it is non taxable event.

Step 3: Sold all the shares on July 1 of year 2, after more than 1 year, which makes it long term capital gain. and applicable for tax

Amount earned by Judy ( 50* $20 Shares) = $1000

Earning for Judy $1000 - $500 = $500, long term capital gain.