The Stock Options Book

PDF of the book's comprehensive table of contents

Preface
Introduction

Part I: Overview of Stock Options and Related Plans
Chapter 1: The Basics of Stock Options
Chapter 2: Tax Treatment of Nonstatutory Stock Options
Chapter 3: Tax Treatment of Incentive Stock Options
Chapter 4: Plan Design Considerations
Chapter 5: Employee Stock Purchase Plans
Chapter 6: Trends in Equity Compensation: An Overview

Part II: Technical Issues
Chapter 7: Financing the Purchase of Stock Options
Chapter 8: Overview of Securities Law Issues
Chapter 9: Tax Law Compliance Issues
Chapter 10: Basic Accounting Issues
Chapter 11: Tax Treatment of Options on Death and Divorce
Chapter 12: Post-Termination Option Issues

Part III: Current Issues
Chapter 13: Legislative and Regulatory Initiatives Related to Stock Options: History and Status
Chapter 14: Option Backdating: Timing of Option Grants
Chapter 15: Cases Affecting Equity Compensation
Chapter 16: Transferable Options
Chapter 17: Reloads, Evergreens, Repricings, and Exchanges

Appendix 1: Designing a Broad-Based Stock Option Plan
Appendix 2: Primary Sources
Glossary
Bibliography
Index

From Chapter 3, "Tax Treatment of Incentive Stock Options" (footnotes omitted)

The spread on exercise of an ISO is subject to alternative minimum tax (AMT) in the year of exercise unless the stock is sold in the same calendar year. Although the specific application of the AMT is too complex to summarize here, generally AMT is exactly what its name suggests: an alternative to the regular tax system. AMT is imposed on alternative minimum taxable income (AMTI) as computed under Sections 56 through 58 of the Code. To arrive at AMTI, the taxpayer computes regular taxable income (as defined in Section 55(c) of the Code) and then adjusts that amount by any adjustments or "tax preference items" (i.e., items that reflect certain deductions and tax deferral benefits allowed under the regular tax system) taken in the taxable year. The spread on exercise of an ISO is treated as a tax preference item.

Under Section 55 of the Code, AMT is computed on the amount of AMTI in excess of the applicable exemption amount ($74,450 for married taxpayers filing jointly and $48,450 for single taxpayers in 2011). If the AMT exceeds the taxpayer's regular tax in a given year, the taxpayer must pay the AMT amount rather than the regular tax amount. The difference between AMT and regular tax in any year is allowable as a credit against regular tax in future years when no AMT is due pursuant to Section 53 of the Code. Thus, for taxpayers who are not regularly subject to AMT, the payment essentially serves as a prepayment of regular tax and accordingly offsets any deferral benefit that the taxpayer would otherwise enjoy in a year when AMT exceeds regular tax.

From Chapter 9, "Tax Law Compliance Issues" (footnotes omitted)

For option exercises and ESPP purchases after the start of 2011, the IRS requires brokers to furnish optionees with Forms 1099-B reflecting the cost basis of the securities. The amount included on the form need only reflect the amount paid for the shares, a requirement that has the potential to lead to over-reporting or even double reporting on the part of plan participants. However, under final rules issued in October 2010, the amount reported may be increased by any amount the optionee must include in income, which means the holders of NSOs will likely receive forms reflecting their true cost basis in the shares. At that time, the IRS also issued transitional relief stating it would not assess penalties for failure to furnish the forms in connection with 2011 transactions in any but the most egregious cases.

Participants in Section 423 ESPPs are particularly likely to be confused by the forms. Although brokers are allowed to increase the reported amount by any amount includible as ordinary income, the reporting requirement is triggered by the purchase of shares—before the amount that must be included in income is known. The ordinary income element of Section 423 plan shares is affected by drops in stock price after the purchase date and by the character of the disposition of shares.

The requirement for the new form was included in the Energy Improvement and Extension Act of 2008, and final rules were published in October 2010. Until more option-specific requirements are crafted in the next few years, companies would be well advised to know—and communicate to employees—which amount brokers are reporting to optionees. Regardless of the method adopted by the reporting broker, participants should be advised to carefully calculate their own tax basis for purposes of their individual tax returns and not rely upon cost basis reported on the 1099-B. Wherever possible, plan sponsors should remind participants that tax basis (as opposed to cost basis) includes exercise price plus any amounts included in ordinary income. Participants should also be encouraged to consult with their tax advisors prior to reporting capital gains (or losses) on ESPP stock.