Stock Options: ISO, NSO, ESPP

Question 1

What is an Employee Stock Purchase Plan (ESPP)?

Answer 1

A plan that allows employees to buy company stock at a discounted rate.

Question 2

What requirements must a company meet in order to be able to offer a qualified ESPP?

Answer 2

1. only offered to employees
2. no options to owners with => 5% all classes voting stock
3. options are not transferable and must be exercised by the employee
4. No more than a 15% discount on options
5. Generally, options must be exercised within 5 years
6. No employee is able to buy > $25,000 of options in one calendar year
7. options must be approved by shareholders

Question 3

What are the holding period requirements for ESPP distributions to be considered Qualified?

Answer 3

TP must hold stock for
1 . => 2 years from offering date (grant date)
AND
2. => 1 year from purchase date (exercise date)

Question 4

What are the tax consequences of a Qualified ESPP distribution?

Answer 4

1. Bargain element is reported on W2 as compensation at time of sale
2. Capital gain/loss is included in TI

• The FMV used to calculate the bargain element is the lesser of:
  1. FMV on grant date or
  2. FMV on purchase date (exercise date)

Actual TP cost for options
- FMV
_____________________
Bargain Element

Question 5

When discussing ESPP what are the following:

1. offering date
2. closing date
3. offering period
4. closing price

Answer 5

1. offering date = date shares are granted to tp (grant date)
2. closing date = date shares purchased for TP (exercise date)
3. Offering period: Starts on offering date and ends on closing date
4. Closing price: FMV of the shares at the closing of that date (ie: closing price on offering date = FMV offering date)

Question 6

How do you calculate the Bargain Element for an ESPP distribution?

Answer 6

For FMV use the lesser of: 
FMV grant (offering date) or FMV exercise (closing date)

FMV
- TP actual cost
_____________
Bargain element

example: 
100 shares 
Grant price: $55/sh
FMV Grant date: $62/sh
FMV Exercise date: $68/sh

Lesser of FMV at grant/exercise 62100 6200
- TP actual cost 55100 (5500)
___________________________________________
Bargain Element (ordinary TI) 700

Question 7

Grant date

Answer 7

The date the employer granted (gives) the options to the employee

Question 8

Vesting date

Answer 8

Date when the employee is eligible to buy (exercise) a specific number of options

Question 9

Exercise Date

Answer 9

The date that the employee actually buys the options

Question 10

Expiration Date

Answer 10

Date that the employee is no longer eligible to exercise (buy) the shares. Usually no more than 10 years after grant or 90 days after leaving the company

Question 11

Exercise Price (Strike Price)

Answer 11

The price at which the taxpayer can purchase the stock.

Question 12

How do you calculate the Bargain Element for ISOs?

Answer 12

FMV on Exercise Date   
- Actual purchase cost  (exercise price)
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
Bargain Element
EX: 
Joe exercises 100 share for $25/ share  
FMV on that date was $45/sh

4500 (45100)
-2500 (25100)
________________
$2000 Bargain Element included as compensation

Question 13

What are the two main types of employee stock options? Who is eligible to receive each type?

Answer 13

Incentive stock options (ISO): employees only

Non-statutory stock options (NSO): former employees, employees, consultants, advisors

Question 14

When is a NSO taxed?

Answer 14

1. Bargain element is taxed as compensation on either:
   a. Grant date if FMV is readily known or
   b. Exercised date
2. Year of Sale: Capital G/L on sale of stock

Question 15

What are two types of ISOs?

Answer 15

1. Qualified

2. Non-qualified

Question 16

What are the holding period requirements for a distribution from an ISO to be considered Qualified?

Answer 16

Holding period:
=> 1 year from exercise date
=> 2 years from grant date

Question 17

What are the tax consequences if the TP sells his ISOs but does not meet the holding period requirement?

Answer 17

Not a Qualified Disposition - In the year of sale:
1) Bargain Element is included in W2 compensation
FMV on exercise date
- Exercise Price
________________
Bargain element

2) No adjustment to AMT income is made
3) Sale is reported on Sched D as Capital G/L

Basis (exercise price)
+ bargain element included in wages
____________________________
Adjusted Basis

Proceeds from Sale
- Adjusted Basis
___________
Capital Gain/Loss

Question 18

What are the tax consequences when a tax payer has a Qualified ISO?

Answer 18

1. In year exercised: Bargain element adjustment to AMT income (FMV - exercise Price)
2. Report no additional W2 income
3. Year of Sale report Capital G/L
   Step:
   1)
   Basis (TP cost)
   + AMT adjustment (Bargain element)
   _______________________________
   Adjusted Basis

2)
 Proceeds
- commission
- Adjusted Basis
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
Capital G/L year of sale