Question

Bell Corporation grants an incentive stock option to Peggy, an employee, on January 1, 2019, when the option price and FMV of the Bell stock is $80.The option entitles Peggy to buy 10 shares of Bell stock. Peggy exercises the option and acquires the stock on April 1, 2021, when the stock’s FMV is $100. Peggy, while still employed by the Bell Corporation, sells the stock on May 1, 2023 for $120 per share.

What are the tax consequences to Peggy and Bell Corporation on the fallowing dates:

January 1, 2019; April 1, 2021; and May 1, 2023? (Assume all incentive stock option qualification requirements are met.

b. How would your answer to Part a change if Peggy instead sold the bell stock for $130 per share on May 1, 2021?

please explain

Answer 1

Answer:

a.   

January 1, 2019- no effect since no tax consequences occur on the grant of an incentive stock option.

April 1, 2021 - no effect except for a $200 [($100 - $80) x 10 shares] tax preference item for purposes of the alternative minimum tax.

May 1, 2023 - $400 long term capital gain is recognized by Peggy, computed as follows:

Peggy is entitled to long-term capital gain treatment since both of the requirements for incentive stock options were met. Bell Corporation does not receive a corresponding compensation deduction.

b.   

Since Peggy did not hold the stock the required holding period, she would recognize $200 ordinary income on the sale date equal to the spread between the option price and the exercise price [($100 - $80) x 10 shares = $200] ordinary ncome on May 1, 2021. Bell Corporation is permitted a $200 deduction for compensation on May 1, 2021 because the option is treated as a nonqualified stock option. On the sale date Peggy also recognizes a STCG of $300 [$1,300 - ($100 x 10 shares)]