After reading this book, you will know:
- tax saving strategies
- what happens when you exercise your option
- what happens when you sell the stock
- how to claim the Alternative Minimum Tax credit
- when and how to make a Section 83(b) tax-saving election
- how to prepare your own audit-proof income tax return
|Publisher:||PCM Capital Publishing|
Read an Excerpt
Chapter 1: IntroductionOption Repricing
Companies use stock options to attract, retain and motivate people. Since stock prices rise and fall, stock options present another challenge for management.
If the price of the underlying stock falls below the option exercise price, the option is said to be "underwater". If the price of the stock falls substantially below the exercise price, the options fair market value may be insignificant or perceived to be insignificant by the people that the corporation. wants to retain.
This situation can present a serious problem for the corporation, especially when a substantial portion of employee compensation consists of stock options. To retain key people, the corporation may feel compelled to reduce the option exercise price in what is called repricing. Obviously, a reduction in the exercise price makes the option more attractive to the optionee.
Even though option repricing increases the fair market value of the option, the optionee does not recognize taxable income as a result of such repricing.
Example: Three years ago, Company A granted options to key employees. Those options gave them the right to buy Company A stock at $60 per share, the fair market value of the stock on the date of grant. The price of the stock is now $30 per share. The option is underwater. Company A's board of directors, concerned that competitors will recruit its key employees, votes to reduce the option exercise price to the $30 current market price.
If the company had not repriced the options, optionees could only realize a gain to the extent that the price of Company A stock rises above $60. After the repricing, optioneescan reap a gain if the price of the stock rises above $30.
Options With A Reload Feature
An option (the "original" option) that contains a reload feature provides that if the optionee exercises such option and pays the exercise price using stock (the "payment shares") which the optionee already owns, the company will automatically award the optionee a new option. The new option is sometimes called a reload option, restoration option, or replacement option.
Generally, if the optionee exercises an option (one containing a reload provision) to buy the company's stock and pays the exercise price with mature stock of that company (instead of using cash), the optionee receives one share of stock upon option exercise and one new option for every share of stock that he uses to pay the exercise price. Sometimes even the new option contains a reload feature so that it too can be "reloaded" on its date of exercise.
The exercise price of each new option is the fair market value of the stock on the date the corporation grants each new option. The new option expires on the same date that the "original" option would have expired.
Mature stock is stock that the optionee already owns, including stock acquired on the open market (for example, through a brokerage firm). It also includes stock that he may have purchased through a company plan if the optionee has satisfied certain holding period requirements with respect to such stock.
In Private Letter Ruling 9629028, the IRS ruled that, in lieu of actually transferring shares to the company, the optionee could make a constructive exchange of such payment shares.
If the payment shares are held by a registered securities broker for the optionee in "street name", the optionee may provide the company with a notarized statement attesting to the number of shares owned that are intended to serve as payment shares. If the stock certificates are held by the optionee, he should provide the company with their certificate numbers.
Upon receipt of such notarized statement or upon confirmation of such share ownership by reference to the company's records, the company treats the payment shares as being constructively exchanged and issues to the optionee a certificate for the net number of shares. The net number of shares equals the number of shares subject to the option exercise less the number of payment shares.
Example: The outstanding stock of Company A consists of one class of common stock. Julia owns one share of Company A stock that she bought on the open market for $5. The current market price is $20. Julia owns nonqualified stock options to buy two shares of Company A stock at an exercise price of $10 per share.
The options expire on January 5, 2007. They contain a reload provision. Julia exercises the options to buy two shares of stock and pays the $20 exercise price by transferring to Company A (or merely certifying that she owns one share of Company A stock) the one share of Company A stock that she bought on the open market. She receives two shares of Company A stock and a new nonqualified stock option (the reload option). The new option has an exercise price of $20, the fair market value of Company A stock on the date the corporation grants the reload option. The reload option expires on January 5, 2007, the same date that the original option would have expired.
In the example above, Julia transfers one share of Company A stock, which has a fair market value of $20, as payment of the exercise price. Julia's transfer of such stock qualifies as a stock-for-stock tax-deferred exchange under IRC Section 1036 "Stock for stock of same corporation". Therefore, she does not recognize a taxable gain on the date of transfer even though the $20 fair market value of the stock exceeds her $5 original purchase price.
Before and After Option Exercise
Before her exercise of the original option, Julia owned and held options to buy three shares of Company A stock (she owned one share and held options to buy two shares). After exercise of the original option, Julia still owns and holds options to buy three shares (she owns two shares and holds an option to buy one share).
If the original option did not have a reload provision, Julia would have owned and held options to buy only two shares after exercising her two options (she would have owned two shares and held no options to buy more shares).
An "original" nonqualified stock option as well as an "original" incentive stock option can have a reload provision...
Table of ContentsChapter 1: Introduction
Chapter 2: Nonqualified Stock Options
Chapter 3: Incentive Stock Options
Chapter 4: Tax Deferred Exchanges
Chapter 5: Two Tax Saving Strategies
Chapter 6: IRS Form 1040 Reporting
What People are Saying About This
...guides you through many tax and portfolio planning issues...recommended reading.
The first edition drew favorable reviews and has become a mainstay reference for tax pros...
San Jose Mercury News, December 14, 1999
...the leading book on options..
PROFIT Magazine, January 2000
I can't remember reading anything that so clearly explains the
concepts. I recommend this book to tax professionals and executives alike.
Lynn Freer, President of Spidell Publishing, Inc.