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    Employee Stock Options: Grant and Exercise

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    Complete Application Problems 3 at the end of Chapter 3 (pages 74-75). For each problem, cite the primary authority you relied on to make your calculations (definition of primary authority on page 477 of Appendix C).

    11. Six years ago, Rollo Inc. granted a nonqualified stock option to Mrs. Jacques to buy 5,000 shares of Rollo stock at $15 per share for six years. At the date of grant, Rollo stock was selling on the AMEX for $14.75 per share. This year, Mrs. Jacques exercised the option when the price was $45.10 per share.

    a. How much compensation income did Mrs. Jacques recognize in the year the option was granted?

    b. How much compensation income did Mrs. Jacques recognize in the year she exercised the option?

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    Solution Preview

    Non-qualified means the agreement withe the employee does not meet the requirements under IRC Sec 421-424 (various types of deferred compensation arrangements including incentive stock options and employee stock purchase plans).

    "Nonqualified stock options are a popular form of equity compensation. Companies like them because they provide a flexible and efficient way to attract, retain and motivate employees...Employees like them because they represent an opportunity to grow wealth, with tax consequences deferred until the year of exercise."

    Generally, there is no taxable event at the grant date because there is no 'readily accertainable fair market value' for the option. That means the options are not trading on an exchange. IRC regulation 1.83-7(a).

    At the exercise date, you announce that you will buy 5000 shares of stock at $15, per the terms of the option agreement. 5000 x 15 = ...

    Solution Summary

    The 643-word solution attempts to present complex tax information about stock options in an understandable format. The solution is cited both to Internal Revenue Code and to other sources. It shows the calculations for valuing stock options, the tax consequences and the affects to the Form W-2. It is a complex subject which required a lengthy explanation.