Question

On Jan 1 of the current year (CY) Gates is given a nonqualified option to purchase

3,000 shares of stock in his employer at $10/ share for the next 10 years. The

current value of the stock is $10/share. If Gates resigns before the end of the

following year (12/31 CY+1) he forfeits the options. The value of the options is

determined to be $23/share. On May 1 of the 3rd

year (CY+2) when the stock is

trading at $50/share Gates gives the company $30,000 to purchase the shares

A.) What if anything is the book expense in years CY, CY+1 and CY+2?

B.) What, if anything happens to Gates from a tax perspective when he exercises the

option?

C.)  What if anything happens to Gates’s employer when Gates exercises the option?

Answer 1

A.) What if anything is the book expense in years CY, CY+1 and CY+2?

The company granting the options is allowed to deduct from income the same value of the options that the recipient includes in income, in the same year it is taxable to the recipient (Section 83(h)).

Therefore, Book expense in years CY, CY+1, CY+2 is

CY = Market value $10 - $10 (ammount paid) = 0

CY+1= Market value $23 - $10 (ammount paid) = $13

CY+1= Market value $50- $10 (ammount paid) = $40

What, if anything happens to Gates from a tax perspective when he exercises the

option?

He is entitled to pay tax at the time of option exercised on the difference between, the ammount which he paid - market value of shares.

The second was that gates could deduct the$39,000 as employee compensation on its own tax return (and would also owe FICA and FUTA taxes on it).

$23(market value)- $10 purcahse value = $13*3000= $39,000

What if anything happens to Gates’s employer when Gates exercises the option?

He received the tax on the compensation which he granted to the Gates.