Question

Antonio received 40 ISOs (each option gives him the right to purchase 20 shares of Zorro stock for $3 per share) at the time he started working for Zorro Corporation six years ago. Zorro’s stock price was $3 per share at the time. Now that Zorro’s stock price is $50 per share, Antonio intends to exercise all of his options and immediately sell all the shares he receives from the options exercise. (Enter all amounts as positive values. Leave no answers blank. Enter zero if applicable.)

Problem 12-31 Part a (Static)

a. What are Antonio’s taxes due on the grant date, the exercise date, and the date the shares are sold, assuming his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent?

Grant date $____

Exercise date & sale date _____

b. What are Zorro’s tax consequences on the grant date, the exercise date, and the date Antonio sells the shares?

Grant date $____

Exercise date & sale date ____

c. What are the cash flow effects of these transactions to Antonio, assuming his ordinary marginal rate is 24 percent and his long-term capital gains rate is 15 percent?

Cash flow consequences

Grant date _____ ________

Exercise date & sale date _____ _________

Answer 1

a. No tax consequence is applicable to antonio on the grant date.

On the exercise date, Antonio has no regular income tax consequences but he will be subject to alternate minimum tax, computation of which is provided as follows:

Particulars	Amount
1) No. of shares acquired (40 ISO*20 shares)	800
2) Exercise Price	$3
3) Required Cash for exercising the right (1*2)	2400
4) Market Price	$50
5) Market value of shares (1*4)	$40000
6) Bargain Element (5-3)	37600

The bargain element is includable in alternative minimum taxable income computation, hence this will require Mark to pay alternate minimum tax.

On sale date, Mark will be subject to following taxes:

Particulars	Amount
1) No. of shares acquired (40 ISO*20 shares)	800
2) Exercise Price	$3
3) Required Cash for exercising the right (1*2)	2400
4) Market Price	$50
5) Market value of shares (1*4)	$40000
6) Bargain Element (5-3)	37600
7) Capital Gains rate	15%
8) Tax Liability (6*7)	$5640

(b) Zorro is not subject to any tax consequences on grant date, exercise date and sale date because the shares are allotted as a part of incentive stock options.

C) Antonio has no cash flow consequences on the grant date.

Since Antonio exercises and sells the shares immediately he has a net cash inflow of $28,576. The disqualifying disposition of ISOs is treated like NQOs. Antonio recognized $40,000 of cash and he pays $2,400 for the stock and $9024 in taxes