Question

Please thuroughly explain your reasoning, provide supporting facts and evidence if possible.

11. Which of the following questions about the tax treatment of nonqualified stock options is (are) correct?

I The employee’s tax basis in the stock received when the option is exercised is equal to the fair market value of the stock, established when the option was granted.

II When the option is exercised, the employee is taxed at ordinary income tax rates on the excess of the fair market value of the stock over the option price.

III The tax deduction the company receives is equal to the amount the participant recognizes from the exercise of the option.

IV When the nonqualified stock option is exercised, the employee’s taxes include FICA and withholding taxes.

(A) I and II only (C) II, III, and IV only

(B) II and III only (D) I, II, III, and IV

Answer 1

Answer:

Question 11:Which of the following questions about the tax treatment of nonqualified stock options is (are) correct?

Answer:(C) II, III, and IV only

I (Incorrect): The employee’s tax basis in the stock received when the option is exercised is equal to the fair market value of the stock, established when the option was granted.

Explanation(Incorrect): Nonqualified stock options may be granted to employees at initial value equal or greater than to the fair market value of a share on the date of grant.Non qualified stock options require payment of income tax of the grant price minus the price of the exercised option.

II(Correct):When the option is exercised, the employee is taxed at ordinary income tax rates on the excess of the fair market value of the stock

Explanation(Correct): Increase in the sale price is subject to the more favorable capital gains rate and market value on the exercise date is subject to ordinary income tax.Nonqualified Stock Options holders must report the price break as taxable compensation in the year opted for Nonqualified Stock options, and it's taxed at your regular income tax rate.

III(Correct): The tax deduction the company receives is equal to the amount the participant recognizes from the exercise of the option.

Explanation(Correct):Federal Income Tax Consequences to the Participant Upon the exercise of a Stock Option, the Participant generally will recognize ordinary income equal to the excess of the fair market value of the shares of Common Stock purchased (as of the exercise date) over the option price.

IV(Correct) :When the nonqualified stock option is exercised, the employee’s taxes include FICA and withholding taxes.

Explanation(Correct):Under current tax law, a nonqualified stock option is generally taxed upon by reporting of FICA taxable income and FICA tax withholding. FICA and FUTA taxes will be due upon exercise of the nonqualified stock option and income tax withholding on the income recognized under the Section 83(i) timing rules.