Question

Yost received 300 NQOs (each option gives Yost the right to purchase 10 shares of Cutter Corporation stock for $30 per share). At the time he started working for Cutter Corporation three years ago, Cutter's stock price was $30 per share. Yost exercised all of his options when the share price was $60 per share. Two years after acquiring the shares, he sold them at $92 per 5 hare. Note: Input all amounts as positive values, Leave no answer blank. Enter zero if applicable. Required: a. What are Yost's taxes due on the grant date, exercise date, and sale date, assuming his ordinary marginal rate is 35 percent and his long-term capital gains rate is 15 percent? b. What are Cutter Corporation's tax consequences (amount of deduction and tax savings from deduction) on the grant date, the exercise date, and the date Yost sold the shares? c. Assume that Yost is "cash poor" and needs to engage in a same-day sale in order to buy his shares. Due to his bellef that the stock price is going to increase signiflcantly, he wants to maintain as many shares as possible. How many shares must he set in order to cover his purchase price and taxes payable on the exerclse? d. Assume that Yost's options were exercisable at $35 and expired after five years, If the stock only reached $33 during its high point during the five-year period, what are Yost's tax consequences on the grant date, the exercise date, and the date the shares are sold, assuming his ordinary marginal rate is 35 percent and his long-term capital gains rate is 15 percent?

Answer 1

a. On the grant date, Yost does not owe any taxes. On the exercise date, Yost owes taxes of $3,150. On the sale date, Yost owes taxes of $2,760. b. On the grant date, Cutter Corporation does not have any tax consequences. On the exercise date, Cutter Corporation can deduct $3,150. On the sale date, Cutter Corporation does not have any tax consequences. c. Yost needs to sell 662 shares to cover his purchase price and taxes payable on the exercise. d. Yost does not have any tax consequences on the grant date or the sale date. On the exercise date, Yost does not owe any taxes because it results in a loss.

Step-by-step explanation:

a. On the grant date, Yost does not owe any taxes because he has not exercised the options or sold the shares yet. On the exercise date, Yost owes taxes on the difference between the stock price ($60) and the exercise price ($30) multiplied by the number of shares (300), which is $9,000. Yost's taxes on the exercise date would be $9,000 * 0.35 = $3,150. On the sale date, Yost owes taxes on the difference between the selling price ($92 per 5 shares) and the exercise price ($30 per share) multiplied by the number of shares (300), which is $18,400. Yost's taxes on the sale date would be $18,400 * 0.15 = $2,760.

b. On the grant date, Cutter Corporation does not have any tax consequences because the options have not been exercised yet. On the exercise date, Cutter Corporation can deduct the difference between the stock price ($60) and the exercise price ($30) multiplied by the number of shares (300), which is $9,000. The tax savings from this deduction would be $9,000 * 0.35 = $3,150. On the sale date, Cutter Corporation does not have any tax consequences because it is the employee who is selling the shares.

c. In order to cover his purchase price and taxes payable on the exercise, Yost would need to sell a portion of his shares. To calculate the number of shares he needs to sell, we need to determine the total amount Yost needs to cover. Yost would need to cover the purchase price ($30 per share) multiplied by the number of shares (300), which is $9,000, and the taxes payable on the exercise ($3,150). The total amount Yost needs to cover is $9,000 + $3,150 = $12,150. To calculate the number of shares he needs to sell, we divide the total amount needed by the selling price per share ($92 / 5 = $18.40 per share). The number of shares Yost needs to sell is $12,150 / $18.40 = 661.41 shares. Since shares cannot be divided, Yost would need to sell 662 shares to cover his purchase price and taxes payable on the exercise.

d. If the stock only reached $33 during its high point, Yost would not have any tax consequences on the grant date or the sale date. On the exercise date, Yost would owe taxes on the difference between the stock price ($33) and the exercise price ($35) multiplied by the number of shares (300), which is -$600. Since this results in a loss, Yost would not owe any taxes on the exercise date. Yost's taxes would be $0.

Answer 2

a) Yost's Taxes

Grant Date:

No taxable event occurs on the grant date.

Exercise Date:

Yost exercises the options at $60 per share, creating a bargain purchase: $60 - $30 = $30 per share.

The bargain element ($30) is considered ordinary income for Yost and taxed at his marginal rate of 35%: $30 x 300 shares x 35% = $31,500 in taxes.

Sale Date:

Yost sells the shares at $92 per share, resulting in a capital gain: $92 - $60 = $32 per share.

Since he held the shares for two years, this is a long-term capital gain and taxed at his long-term capital gains rate of 15%: $32 x 300 shares x 15% = $14,400 in taxes.

Total Taxes:

$31,500 (exercise) + $14,400 (sale) = $45,900 in total taxes.

b) Cutter Corporation's Tax Consequences

Grant Date:

Cutter Corporation can deduct the fair value of the NQOs on the grant date as compensation expense.

However, the fair value cannot be determined until the exercise date.

Exercise Date:

On the exercise date, Cutter Corporation can deduct the difference between the fair value of the shares and the option price as compensation expense:

Fair value of shares: $60 per share

Option price: $30 per share

Difference: $30 per share

Total deduction: $30 x 300 shares = $9,000

Tax savings: $9,000 x corporate tax rate (assuming 25%) = $2,250

Sale Date:

Cutter Corporation has no further tax consequences related to the sale of the shares by Yost.

Total Tax Savings:

$2,250 (exercise) = $2,250 in total tax savings.