334 Planning and Forecasting
be transferable; no more than $100,000 of underlying stock may be initially ex-
ercisable in any one year by any one employee; the exercise price of the options
must be no less than the fair market value of the stock on the date of grant; and
the options must expire substantially simultaneously with the termination of
the employee’s employment. Perhaps most important, the underlying stock may
not be sold by the employee prior to the expiration of two years from the option
grant date or one year from the exercise date, whichever is later.
This latter requirement has led to what was probably an unexpected con-
sequence. Assume that Plant Supply has granted an incentive stock option to
Brad. Assume further that Brad has recently exercised the option and has plans
to sell the stock he received. It may occur to Brad that by waiting a year to re-
sell, he will be risking the vagaries of the market for a tax savings which cannot
exceed 19.1% (the difference between the maximum income-tax rate of 39.1%
and the maximum capital-gain rate of 20%). By selling early, Brad will lose the
chance to treat the option as an incentive stock option but will pay, at worst,
only a marginally higher amount at a time when he does have the money to pay
it. Furthermore, by disqualifying the options, he will be giving his employer a
tax deduction at the time of exercise. An enterprising employee might go so far
as to offer to sell early in exchange for a split of the employer ’s tax savings.
Tax Impact on Restricted Stock
The taxation of restricted stock is not markedly different from the taxation
of nonqualified stock options without a readily ascertainable value (see Ex-
hibit 11.6). Restricted stock is defined as stock that is subject to a condition
that affects its value to the holder and which will lapse upon the happening of
an event or the passage of time. The Code refers to this as “a substantial risk of
forfeiture.” Since the value of the stock to the employee is initially speculative,
the receipt of the stock is not considered a taxable event. In other words, since
Brad may have to forfeit whatever increased value his stock may acquire, if he
leaves the employ of the corporation prior to the agreed time, Congress has al-
lowed him not to pay the tax until he knows for certain whether he will be able
to retain that value. When the stock is no longer restricted (when it “vests”),
EXHIBIT 11.6 Restricted stock tax impact.
Grant Restriction Removed SaleRestricted Stock
Employee No tax Tax based on current value Capital gain
Employer No Deduction Deduction No deduction
Restricted Stock 83(b) Election
Employee Tax based on value without No tax Capital gain
restriction
Employer Deduction No deduction No deduction