How it works: An executive wants to purchase 1000 shares of the company stock. The option price is twenty dollars a share when the market price is forty dollars a share. The executive already owns company stock for which he paid ten dollars a share. The executive exchanges five hundred of the old shares at their market value of forty dollars each (twenty thousand dollars) for the one thousand new shares (also twenty thousand dollars).
Result: The employee must treat the difference between the new shares' option
price and their market value (twenty thousand dollars) as compensation.
Comparison: An employee who purchases the new stock for cash has the same taxable
gain. But twenty thousand also has to be paid for the stock. Net cash outlay:
thirty thousand dollars. That's three times the cash that would have been necessary
in a stock exchange.
The IRS has approved option stock exchanges. The law specifically permits use
of corporate stock to pay for stock in the same corporation acquired on exercise
of an incentive stock option. And the Securities and Exchange Commission has
said that these exchanges may be undertaken by corporate insiders.
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