5. Susan has been granted stock options by her firm. Her exercise price is $18 p

Question

5. Susan has been granted stock options by her firm. Her exercise price is $18 per share and the current Fair Market Value (FMV) of the stock is $20 per share. Susan can elect to be taxed at ordinary income tax rates at this point in time or she can wait until she exercises the stock option at which time she will be taxed on the difference between the FMV of the stock and the exercise price at the time she exercises the option(at ordinary income tax rates). Susan has options on 10,000 shares. The capital gains tax rate if stock is held for more than one year is 15% and Susan

Explanation / Answer

a) 10000 share if she exercises after one year at FMV = 23, she will be taxed at ordinary rate of 38% = shares * (FMV value-option price)* tax rate = 10000 * (23-18) * 38% = 19000 She will sell them at 25 after one year She will be taxed at 15% for the gain = 10000 * 15% * (25 - 23) = 3000 Total tax = 19000+3000 = 22000 If susan is taxed now She will be taxed at 10000*(20-18)*38% = 7600 She will exercise the options after one year and sell them after one more year at 25 when she will pay capital gains tax = 10000*(25-18)*15% = 10500 Total tax in this scenario = 7600 + 10500 = 18100 So susan should choose to be taxed now. b) In this case by substituting the new values. If she is taxed later, total tax = income tax + capital gains tax = 10000*(21-18)*28% + 10000*(25-21)*20% = 8400 + 8000 = 16400 If she is taxed now, total tax = income tax + capital gains tax = 10000*(20-18)*38% + 10000*(25-20)*20% = 7600 + 10000 = 17600 In this scenario susan should choose to be taxed later. Thanks in advance for rating! :)

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