Question

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Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation packages from which Pratt may choose. Pratt will start working for Ferndale on January 1, year 1.

Benefit Description Option 1 Option 2 Option 3 Option 4 Salary $ 60,000 $ 50,000 $ 45,000 $ 45,000 Health insurance No coverage $ 5,000 $ 5,000 $ 5,000 Restricted stock 0 0 1,000 shares 0 NQO's 0 0 0 100 options Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1) and are expected to be worth $10 per share on the vesting date at the end of year 1 and that no 83(b) election is made. Assume that the NQOs (100 options that each allow the employee to purchase 10 shares at $5 exercise price). The stock trades at $5 per share on the grant date (January 1, year 1) and is expected to be worth $10 per share on the vesting date at the end of year 1 and that the options are exercised and sold at the end of the year. Also assume that Pratt spends on average $3,000 on health-related costs that would be covered by insurance if he has coverage. Assume that Pratt's marginal tax rate is 35 percent. Assume that Pratt spends $3,000 in after-tax dollars for health expenses when he doesn't have health insurance coverage (treat this as an outflow), and that there is no effect when he has health insurance coverage. (Ignore FICA taxes and time value of money considerations).

c. Assuming Pratt chooses Option 3 and sells the stock on the vesting date (on the last day of year 1), complete Pratt’s Schedule D and Form 8949 for the sale of the restricted stock. (Input all the values as positive numbers. Use 2018 tax rules regardless of year on tax form.)

Answer 1

Pratt should select option 1 ($36,000) because it maximizes his after tax value

The solution assumes that no 83(b) election is made for option 3.paratts after- \tax value for each of the options is $36,000,$32,500,$35,750,and$35,750 respectively,caluclated as follows

description amount explanation

salary $60,000   

restricted stock $0

taxable total $60,000 1+2

tax rate 35% given

tax paid $21,000 3*4

after tac cash value $39,000 3-5

NQO $0 given

health care expensens $3,000 given

after tax vale $36,000 6+7-8