Assignment 5 - Stock Compensation Plans Flashcards
Type of EE Stock Comp Plan
*there is a law that specifically describes this type of plan and provides certain benefits to the company or EEs provided the rules are followed
- tax law accords special tax advs. but that must meet certain requirements to be elig. for the adv.
Statutory EE Stock Comp. Plan
- Type of EE Stock Comp Plan
- only the general rules regarding company stock and taxes are considered
- not based on any special tax provisions, but rather are governed by general tax principles.
- governed by Sect’s 61 abd 83 - related to income
Nonstatutory EE Stock Comp. Plans
Reasons for Employee Stock Comp. Plans
- increases EE’s tie to the company
- encourages EEs to do things that help improve the value of the company
- ties the EE’s rewards to the success of the company
- financially it can be cheaper than giving cash
TYPES:
Incentive Stock Options (ISO)
EE Stock Purchase Plans
Statutory
Stock Compensation Plans
TYPES:
Current Stock Bonus
Nonqualif’d Stock Options (NQSO)
Restricted Stock
Stock Appreciation Rights (SARs)
Phantom Stock
Non-Statutory
Stock Compensation Plans
When does the EE have rights to the stock?
Vesting
Are there time limits regarding how long the EE has to take action, such as “exercising the option”?
Duration
- A contract which gives the buyer (owner) the right, not the obligation, to buy or sell an underlying asset or instrument at a specific date
- a choice to buy the stock at a later date for a price set today
Option
fixed price of an option at which the owner of the option can buy or sell the underlying asset
Strike/Exercise price
- Owner of an option has the right to require the fin. trans. specified by the contract to be carried out immed. b/w the two parties causing the option contract to be term’d
- owner of the option purchases the underlying shares (that they were promised when originally buying the options)
Exercising the option
Can the EE give this option to someone else (family)
transferability
How does the EE actually get the stock?
Exercise Features
- cash exercise
- stock-for-stock exercise
- cashless exercise
- reload options
income tax imposed for ISOs at the time of exercise
spread price (diff b/w strike/option price and fair mkt value) is included in this
applies to taxpayers who have certain types of income that receive favorable treatment, or who qualiyf for certain dedcutions.
signif. reduce reg. tax of these taxpayers w/ higher econ. incomes (to a maximum amt)
Alternative Minimum Tax (AMT)
- Statutory EE Stock Comp. type
- available to all EEs, but normally given to HCEs
- can be discrim.
- EE doesn’t have to pay taxes at either the grant or the exercise of the option
- Section 422
- duration - max of 10 years
- option price - equal to or greater than date granted (1st time must be less than $100,000)
- holding period - min 2 years or 1 yr after exercise of option
- transferability - NO (except at death)
Incentive Stock Options (ISO’s)
- Statutory EE Stock Comp. type
- EE elects to buy stock through P/R
- voluntary and generally offered all EEs
- purchase usually at a discount
- disc. limits - cannot be less than 85% of FMV when option is exercised or granted.
- Section 423
- nondiscrim - cannot favor HCEs
EE Stock Purchase Plan
- NON-Statutory EE Stock Comp. type
- usually granted to certain EEs - discrimin.
- do not qualify for special tax treatment - taxed by general terms
- more flexible than ISO - w/ wide range of features decided on by ER
- often granted at FMV of stk on date of grant for option terms of around 10 yrs
Nonqualified Stock Options (NQSO’s)
- company tells EE it has been given stock, but puts restrictions on it.
- EE will need to be w/ the copmany for a certain # of years before taking actual ownership of the stock.
- ER grats stock to EE
- major risk of forfeiture
- When it comes for EE to get stock, they don’t have to pay anything for it
Restricted Stock
- type of stock option exercise
- stock-for-stock had been used, method would give the EE a remaining option equal to the # of shares used in the stock-for-stock exercise
Reload Option
(3) Values of stock options
- intrinsic value
- MV price - strike price for stock
- most ppl think is the value of a stock option
- actual value
- what did the EE get as a result of the option?
- if option isn’t exercised = $0.00
- IRC section that deals w/ taxation of property transferred in connection w/ the perf. of services.
- (b) section - indiv. can elect w/in 30 days of a transfer to include the FMV of the transferred prop. (stock) in his/her gross income currently
- an EE can elect to pay tax at the time of grant even though it is subj. to substantial risk of forfetiture exists
Section 83
unlike most traded options that have relatively short durations, these investments are L/T and publicly traded options.
Leaps
another name for ‘economic value’ of a stock
Fair Value of Stock
- type of stock option exercise
- when a stock option is exercised by selling sufficient shares to cover the purchase price and brokerage cost, delivering the remaining shares to the option holder.
cashless exercise
diff b/w the fair MV of the stock at exercise and the option price
Bargain Element
stated price on a stock option
strike price
term for the diff. b/w an underlying stock’s current market price and the option’s strike price
Intrinsic Value
methods for exercising the option
- cash exercise
- stock-for-stock exercise
- cashless exercise
- reload options
TAXATION
Incentive Stock Options (ISO’s)
- EE: taxed only when they sell the stock purch’d under the option plan; taxed as cap gain
- ER: since it is never treated as comp to the EE, ER never receives tax deduction
TAXATION
EE Stk Purch. Plan
- EE - no gross income for partic. EEs at grant or exercise; UNLESS they dispose of stk w/in 2 yrs of grant or w/in 1 yr from its exercise (then taxed as ordincary income)
- ER - no tax ded.
IRC section that defines gross income for fed’l income tax purposes
Section 61
TAXATION
Nonqualified Stock Options (NQSO’s)
- regular tax based on section’s 61&83 - additional taxable income to recipient at time these are exercised based on the difference b/w the exercise price and MV
- ER gets tax deduction when EE exercises option
TAXATION
restriction stock
- Section 83 applies
- EE taxed when EE takes full ownership of stock
- ER gets corp. income tax ded when EE receives gross comp income
- type of stock option exercise
- optionholder pas the option price to ER
- stk is then transferred to him/her
cash exercise
- type of stock option exercise
- pay exercise price by delivering shares of ER’s stk that they own that are equal in value to option price to ER
- option stk then transferred to them
stock-for-stock exercise
valuation of EE stock options
- complex - ESO’s are call options for EE’s on ER stk
- when ERs “expense” options when they vest
- when EE’s want to know what they are really worth
- valued when EE’s asset allocation planning
- EE’s want to know what they are worth during an exchg (such as for stock-for-stock)
- for estate planning
(6) factors used by Black-Scholes option pricing model
- option exercise price (strike price)
- current mkt price of underlying stk
- risk-free i/r during expected term of option
- expected div. yield on stk
- expected life of option
- expected volatility of the underlying stk’s mkt price
