| Statutory Stock Option Plans. | | | | advantage in utilizing a statutory stock option. |
| Generally, property transferred to an employee in | | | | Non-statutory Stock Option Plans. |
| connection with services performed by the employee, | | | | A non-statutory stock option plan is simply one that |
| results in ordinary income to the employee and a | | | | does not meet the requirements of a statutory plan. |
| deduction to the employer. The Code does provide for | | | | Generally, the employee will realize ordinary income at |
| special tax treatment for statutory stock options. The | | | | the time that the option is granted. Income recognition is |
| transfer of a statutory stock option to an employee | | | | deferred, however, if the employees' rights to the |
| has no tax consequence until the employee sells the | | | | stock are not vested or if the stock does not have a |
| stock. At that time, the employee pays capital gains | | | | readily ascertainable fair market value. Although |
| tax (generally 15%) on the difference between the | | | | income recognition deferral is a general goal of tax |
| option price and the amount received. However, if the | | | | planning, in this case, the advantage of deferral must |
| option price was less than the fair market value at the | | | | be weighed against the disadvantage that the |
| time the option was granted, the employee must | | | | appreciation in the stock is taxed as ordinary income |
| recognize ordinary income (taxed up to 35%) on the | | | | (up to 35% rate) rather than capital gain (usually a 15% |
| difference between the option price and the fair | | | | rate). |
| market value at the time the option was granted. | | | | In some circumstances, the employee may elect to |
| As this is extremely confusing, an example is | | | | recognize income at the time that the option is granted. |
| appropriate: | | | | By doing so, appreciation in the stock is taxed at |
| In year one, Employer (GM) gives Employee a five | | | | capital gains rate when the stock is sold. |
| year statutory stock option to purchase one share of | | | | Employers are entitled to a deduction equal to the |
| GM for $100. At the time, shares of GM have a fair | | | | ordinary income recognized by the employee. The |
| market value of $100. In year 3, when shares of GM | | | | employer may not claim this deduction until the year |
| have a fair market value of $150, Employee exercises | | | | the employee includes the income in his/her return. The |
| the option by paying GM $100 for the share of stock. | | | | employer may also have capital gain or loss when the |
| In year five, Employee sells stock to a 3rd party for | | | | option is exercised equal to the option price minus the |
| $200. | | | | employer's basis in the stock. |
| There is no tax consequence to any party in year one. | | | | It is more difficult to value a stock option than the |
| In year three, Employee does not recognize any | | | | underlying stock. The stock option value is based on |
| income. GM may have capital gain income equal to the | | | | the value of the underlying stock and the option |
| $100 received minus GM's basis in the share. In year | | | | privilege. Accordingly, it is more likely that a stock |
| five, employee will have a $100 capital gain. GM does | | | | option will not have a "readily ascertainable value." This |
| not receive a deduction. | | | | means that the stock option is less likely to be |
| Numerous requirements must be met to qualify as a | | | | immediately taxable to the employee (and deductible |
| statutory stock option. They provide a tax advantage | | | | to the employer). This also means that an employee is |
| for the employee in that tax on the appreciation is | | | | less likely to be eligible to make an election to |
| deferred until sale and the appreciation is taxed at a | | | | immediately recognize income (to avoid ordinary |
| capital gains rate. There is no tax advantage for the | | | | income taxation on stock appreciation). |
| employer, however, because no deduction is allowed. | | | | For this reason, it is sometime preferable to issue |
| If the employer's marginal tax rate is as high as the | | | | stock bonuses rather than stock options. |
| employees' marginal tax rate, there may be no overall | | | | |