Academic journal article Journal of Accountancy

Stock Options

Academic journal article Journal of Accountancy

Stock Options

Article excerpt

Many companies allow their employees to exercise stock options by tendering previously owned shares and cash in exchange for new shares. In private letter ruling 9629028, a corporation with an incentive stock option (ISO) plan and a nonqualified stock option (NQSO) plan was allowed to let its employees make a "constructive exchange" (not physical exchange) of the shares already owned instead of mailing them to the corporation. The Internal Revenue Service taxed the employees based on the type of plan. According to Internal Revenue Code section 422(a), the employee must hold the stock until it is mature, that is for more than two years after the ISO is granted and more than one year after the stock is transferred in order to receive tax benefits.

Assume that employee E owns 1,000 shares, bought five years ago at the option price of $5 per share, when the stock was selling for $7 a share. E has an option to buy an additional 5,000 shares at $10 a share, with the stock selling for $20 a share. In a constructive exchange, E will simply keep the original 1,000 shares and send in a check for $30,000 (cost of new shares [$50,000]-current fair market value [fmv] of old shares [$20,000]), and receive 5,000 additional shams.

ISO Plan. If the 1,000 shares offered as payment are mature ISO shares and the 5,000 shares are offered under an ISO plan:

* E will recognize no gain on the constructive exchange of the 1,000 shares. …

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