Question

Comprehensive Problem 12-53 (LO 12-1, LO 12-2, LO 12-3)

Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation packages from which Pratt may choose. Pratt will start working for Ferndale on January 1, year 1.

  

Benefit Description	Option 1	Option 2		Option 3			Option 4
Salary	$60,000	$	50,000	$	45,000		$	45,000
Health insurance	No coverage		5,000		5,000			5,000
Restricted stock	0		0		1,000	shares		0
NQOs	0		0		0			100	options

Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1) and are expected to be worth $10 per share on the vesting date at the end of year 1. Each NQO allows the employee to purchase 10 shares at a $5 strike price). The stock trades at $5 per share on the grant date (January 1, year 1) and is expected to be worth $10 per share on the vesting date at the end of year 1. Also assume that Pratt spends on average $3,000 on health-related costs that would be covered by insurance if he had coverage. Assume that Pratt’s marginal tax rate is 35 percent. Assume that Pratt spends $3,000 in after-tax dollars for health expenses when he doesn’t have health insurance coverage (treat this as an outflow), and that there is no effect when he has health insurance coverage. (Ignore FICA taxes and time value of money considerations). (Leave no answers blank. Enter zero if applicable.)

Comprehensive Problem 12-53 part c

c. Assuming Pratt chooses Option 3 and sells the stock on the vesting date (on the last day of year 1), complete Pratt’s Schedule D and Form 8949 for the sale of the restricted stock.

Answer 1

The solution assumes that election is made for Option 3. Pratt’s after-tax value for each of the options is $36,000, $32,500, $35,750, and $35,750 respectively, calculated as follows:

Option 1

Description. Amount. Explanation (1) Salary . $60,000. Given. (2) Restricted Stock. $0. Given. (3) Taxable Total. $60,000. (1) + (2) (4) Tax Rate . 35% Given

(5) Tax Paid. $21,000. (3) x (4) (6) After-tax cash value. $39,000. (3) – (5) (7) NQO’s. $0. Given. (8) Health care expenses. $3,000. Given. After-tax value. $36,000. (6)+(7)-(8)

Option 2.

Description. Amount . Explanation (1) Salary. $50,000. Given

(2) Restricted Stock. $0. Given. (3) Taxable Total. $50,000. (1) + (2) (4) Tax Rate. 35% Given. (5) Tax Paid. $17,500 . (3) x (4) (6) After-tax cash value. $32,500. (3) – (5) (7) NQO’s. $0 . Given. (8) Health care expenses. $0. Given After-tax value. $32,500. (6)+(7)–(8)

Option 3.

Description. Amount. Explanation. (1) Salary. $45,000. Given. (2) Restricted Stock. $ 10,000. Given. (3) Taxable Total. $55,000. (1) + (2) (4) Tax Rate. 35% Given . (5) Tax Paid. $19,250. (3) x (4) (6) After-tax cash value. $35,750. (3) – (5) (7) NQO’s. $0

(8) Health care expenses. $0. Given. After-tax value. $32,500. (6) + (7)–(8)

Option 4

Description. Amount. Explanation (1) Salary. $45,000. Given. (2) NQO’s. $10,000. (3) Taxable Total. $55,000. (1) + (2) (4) Tax Rate. 35% Given. (5) Tax Paid. $19,250. (3) x (4) (6) After-tax cash value. $35,750 . (3) – (5)(7) Health care expenses . $0. Given. After-tax value. $35,750. (6) - (7)