Category: Compensation & Employee Benefits; Individuals Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Options granted shortly after 12/31/90. Conversion of stock from one class into two occurred in December 1993. Exercise of the options occurred at that time. I assume the ISO plan was actually approved by the shareholders within 12 months of its adoption. I assume the approval procedure was in accordance with all provisions of applicable state law, and all applicable provisions of the corporate bylaws and charter. Conclusions, Observations, and Queries I am also concerned about the apparent fact that the stock to be issued pursuant to the option agreement comes from the hands of the existing shareholders. I assume there is a side agreement in place in which these shareholders agree to sell shares to the option holders. An ISO must be granted by the corporate employer of the optionee, but in this case, the corporate employer is granting an option to purchase something owned by someone else, namely one or more of the existing shareholders. In this case, the corporation is really acquiring stock from a third party on behalf of the option holders. I believe it could be argued that the options in this case are not ISOs for that reason alone. I cannot locate any instance in which this issue has been raised. If the options really do turn out to be ISOs somehow, the AMT inclusion of the spread between the option price and the fair market value at the date of exercise is controlled by the rules of Section 83. House Report No. 100-795 (P.L. 100-647), p. 90. The optionee's inability to transfer the shares at the date of exercise delays taxation of the spread for AMT purposes until the restrictions lapse. Lack of transferability is clearly a restriction sufficient to delay taxability under Section 83. If the options are not ISOs, as I believe is the case, the employees are taxable (as wages) at the time the restrictions lapse on the spread between the fair market of the stock on the date the restrictions lapse and the option price. The employer should also be entitled a compensation deduction at that point. The wage withholding implications of all this should be pursued. It seems to me that the transaction in which the original common stock was converted into Class A and Class B common shares is an E reorganization. How was the transaction handled on the corporate tax return? I assume that the existing shareholders received the option price for the shares. Since the option price did not take into account appreciation, is there some sort of taxable gift or some other tax characterization of this transfer of value that affects the original shareholders? |
