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					                    Keir Employee Benefits – Cardello Supplements

Incentive Stock Option (ISO)
Slide 56

  An ISO is a tax favored stock compensation plan where executives receive options to buy stock at a
  reduced price and are not taxed until the stock is SOLD. However, the excess of the stocks FMV over
  the exercise price when the option is exercised is a tax preference item for purposes of the AMT.

  A. Identify the requirements for a qualifying ISO.
     1. The plan must be in WRITING and be approved by the corporation’s shareholders within 12
        months of its adoption.
     2. The stock’s exercise price cannot be less than its FMV on the grant date.
     3. The stock must be held TWO years after its grant date and ONE year after its exercise date to
         receive LTCG treatment. Otherwise, the gain on sale is treated as OI.
     4. The maximum stock value is $100,000 per year and the maximum exercise period is TEN years.
        The stock’s FMV for this test is determined at the GRANT date.
     5. If a ten percent or more owner the option price must be 110 percent of the stock’s FMV and the
        option period cannot exceed FIVE years.
     6. The employee must remain employed by the grantor or its parent or subsidiary until 3 months
        before exercise.
     7. Qualifying ISO’s cannot be transferred except at the employee’s DEATH, so they should be
        included in the will.

     Note: If these requirements are not met any gains on the stock will be taxed as OI and the
           employer gets a deduction.

  B. Example:
     On July 1, 2000 ABC grants “X” an ISO for 100 shares at its then FMV of $20 per share until July
     1, 2003. Assume “X” exercises the option on June 1, 2003 when the stock’s FMV is $50 per
     share. Taxpayer “X” eventually sells the stock on 10-5-08 for $80 per share.
     Part A: Identify the ramifications to “X” on each of the following dates.

                                       Grant               Exercise            Sale
                                       Date:               Date:               Date:
                                       7-1-00              6-01-03             10-5-08

           “X” writes a check

           “X”’s AMT Preference
                    Item

           “X”’s OI

           “X”’s LTCG



      Part B: Explain the ramifications if he sold the stock for $75 on March 15, 2004.


           Gain on sale                                Employer Deduction
                                                       (matching principle)
                     Keir Employee Benefits – Cardello Supplements

Incentive Stock Option (ISO)
Slide 56

  An ISO is a tax favored stock compensation plan where executives receive options to buy stock at a
  reduced price and are not taxed until the stock is SOLD. However, the excess of the stocks FMV over
  the exercise price when the option is exercised is a tax preference item for purposes of the AMT.

  A. Identify the requirements for a qualifying ISO.
     1. The plan must be in WRITING and be approved by the corporation’s shareholders within 12
        months of its adoption.
     2. The stock’s exercise price cannot be less than its FMV on the grant date.
     3. The stock must be held TWO years after its grant date and ONE year after its exercise date to
         receive LTCG treatment. Otherwise, the gain on sale is treated as OI.
     4. The maximum stock value is $100,000 per year and the maximum exercise period is TEN years.
        The stock’s FMV for this test is determined at the GRANT date.
     5. If a ten percent or more owner the option price must be 110 percent of the stock’s FMV and the
        option period cannot exceed FIVE years.
     6. The employee must remain employed by the grantor or its parent or subsidiary until 3 months
        before exercise.
     7. Qualifying ISO’s cannot be transferred except at the employee’s DEATH, so they should be
        included in the will.

     Note: If these requirements are not met any gains on the stock will be taxed as OI and the
           employer gets a deduction.

  B. Example:
     On July 1, 2000 ABC grants “X” an ISO for 100 shares at its then FMV of $20 per share until July
     1, 2003. Assume “X” exercises the option on June 1, 2003 when the stock’s FMV is $50 per
     share. Taxpayer “X” eventually sells the stock on 10-5-08 for $80 per share.
     Part A: Identify the ramifications to “X” on each of the following dates.

                                        Grant               Exercise            Sale
                                        Date:               Date:               Date:
                                         7-1-00              6-01-03            10-5-08

           “X” writes a check                                $2,000

           “X”’s AMT Income                 0                $3,000 *           ($3,000)**

           “X”’s OI                         0                   0                   0

           “X”’s LTCG                       0                   0               $6,000 ($8k - $2k)

           *    The excess of the stocks FMV over the exercise price when the option is exercised is a
                tax preference item for purposes of AMT. ($5,000 - $2,000 = $3,000 excess.)
           **   The prior AMT preference item in 2003 reverses and creates a credit in 2008, the year of
                sale.

      Part B: Explain the ramifications if he sold the stock for $75 on March 15, 2004.


           Gain on sale         $5,500 OI               Employer Deduction          ($5,500)
                                ($7,500-$2,000)         (matching principle)

       The stock must be held TWO years after its grant date and ONE year after its exercise date to
       receive LTCG treatment. Otherwise, the gain on sale is treated as OI.
                     Keir Employee Benefits – Cardello Supplements

Nonqualified Stock Option
Slide 59

     A non-qualified stock option to buy employer stock is one that does NOT meet all the requirements
     of an ISO. For example, the options are for more than $100,000, extend for more than 10
     years, or do not meet the special rules for TEN percent or more owners.

     1. Describe the tax treatment for a nonqualified stock option.
        Grant Date
        On the grant date, the options are includible as ordinary income only if their FMV is readily
        ascertainable which has generally been limited to publicly traded options. Thus, for closely
        held corporations income isn’t usually recognized until the EXERCISE date.

         Exercise Date
         At the exercise date, the options are taxed as OI and subject to payroll taxes measured by the
         difference between the option’s exercise price and the stock’s current FMV. The subsequent
         stock sale gets LTCG treatment after adjusting the stock basis for the income recognized at the
         date of exercise.

         NOTE: If the options are taxed at GRANT date, there is no taxable income at exercise date.

     2. Example:
        On July 1, 2000 ABC grants “X” the right to purchase 100 shares of its stock for $30 per share
        until July 1, 2005. The stock had a FMV of $28 per share but the FMV of the options was not
        readily ascertainable. Assume “X” exercises the option on June 1, 2005 when the stock’s FMV
        is $50 per share. Taxpayer “X” eventually sells the stock on 10-5-08 for $80 per share. Identify
        the ramifications to “X” on each of the following dates assuming the options were nonqualified.

                                        Grant               Exercise             Sale
                                        Date:               Date:                Date:
                                         7-1-00              6-01-05             10-5-08

           “X” writes a check

           “X”’s AMT Income

           “X”’s OI

           Employer Deduction

           “X”’s LTCG




               Note: The employer deducts                in salary expense in 2005.
                     Keir Employee Benefits – Cardello Supplements

Nonqualified Stock Option
Slide 59

     A non-qualified stock option to buy employer stock is one that does NOT meet all the requirements
     of an ISO. For example, the options are for more than $100,000, extend for more than 10
     years, or do not meet the special rules for TEN percent or more owners.

     2. Describe the tax treatment for a nonqualified stock option.
        Grant Date
        On the grant date, the options are includible as ordinary income only if their FMV is readily
        ascertainable which has generally been limited to publicly traded options. Thus, for closely
        held corporations income isn’t usually recognized until the EXERCISE date.

         Exercise Date
         At the exercise date, the options are taxed as OI and subject to payroll taxes measured by the
         difference between the option’s exercise price and the stock’s current FMV. The subsequent
         stock sale gets LTCG treatment after adjusting the stock basis for the income recognized at the
         date of exercise.

         NOTE: If the options are taxed at GRANT date, there is no taxable income at exercise date.

     2. Example:
        On July 1, 2000 ABC grants “X” the right to purchase 100 shares of its stock for $30 per share
        until July 1, 2005. The stock had a FMV of $28 per share but the FMV of the options was not
        readily ascertainable. Assume “X” exercises the option on June 1, 2005 when the stock’s FMV
        is $50 per share. Taxpayer “X” eventually sells the stock on 10-5-08 for $80 per share. Identify
        the ramifications to “X” on each of the following dates assuming the options were nonqualified.

                                        Grant               Exercise             Sale
                                        Date:               Date:                Date:
                                         7-1-00              6-01-05             10-5-08

           “X” writes a check               0                $3,000              None

           “X”’s AMT Income                 0                    0                   0

           “X”’s OI                         0                $2,000 *                0

           Employer Deduction              0                 ($2,000)                0

           “X”’s LTCG                       0                    0               $3,000 **

           *  At the exercise date, the options are taxed as OI and subject to payroll taxes measured
              by the difference between the option’s exercise price ($3,000) and the stock’s current
              FMV ($5,000).
           ** The stock sale gets LTCG treatment after increasing the stock basis ($3,000)for the
              income recognized at the date of exercise ($2,000). Sales price of $8,000 - $5,000 basis
                   = $3,000 LTCG.

               Note: The employer deducts $2,000 in salary expense in 2005.
                     Keir Employee Benefits – Cardello Supplements

Miscellaneous Employees Incentives
Slide 72

   A. Distinguish between Phantom Stock and Stock Appreciation Rights.
     1. Stock Appreciation Rights
       Similar to stock options except they generally give the employee the right to receive CASH rather
       than shares of stock. The amount of cash equals the excess of the stock’s FMV over its option
       price at the time of the exercise so no cash outlay is required by the employee. The employee is
       taxed at OI rates and the employer gets a deduction for the same amount.

     2. Phantom Stock
       Phantom stock is similar to stock appreciation rights but the employee receives stock units based
       on performance. The value is determined based on either the stock’s entire FMV or its
       APPRECIATION. Also, they are not exercised but the employee receives cash at separation of
       service based on the stocks FMV or appreciation (including dividends) since the grant date. The
       employee is taxed at OI rates and the employer gets a deduction for the same amount.

  B. Describe the two most common executive life insurance plans.
     1. Split Dollar Life Insurance
        An arrangement where the employee and the employer purchase permanent life insurance with
        the employer paying an amount equal to the increase in CASH value and the employee pays the
        balance. The employee is taxed on the lesser of the PS-58 rates or the cost of the policy
        reduced by his or her contribution. If the employee dies or the policy is cancelled, the employer
        gets the CASH value and the employee (or the beneficiaries) receive the balance.

     3. Key Employee Life Insurance
        Key employee life insurance is a policy on a key employee owned by the COMPANY, not the
        employee. The employer pays the NONDEDUCTIBLE premiums and receives the nontaxable
        proceeds (subject to AMT) when the employee dies. They are used to fund DBO plans or to
        provide LIQUIDITY for other deferred compensation plans of the company. Since there are no
        benefits paid to the employee, there are no tax consequences to the employee in this type of
        plan.

  C. Distinguish between Stock Purchase Plans, Restricted Stock Plans, and Junior Stock Plans
     1. Stock Purchase Plans (Section 423 Plans)
        Limited to employees, it allows them to purchase up to $25,000 of employer stock annually
       using payroll deduction. A discount of up to 15 percent of FMV is permitted without the
       employee having to recognize income. For LTCG treatment, the stock must be held TWO years
       after the grant and ONE year after exercise (otherwise OI).

     2. Restricted Stock Plans
        Stock given to an executive usually at no cost that has restrictions STAMPED on the shares
        requiring their forfeiture if employment is terminated before a specified date. Tax is deferred
        until the substantial risk of forfeiture expires and then taxed as OI and is DEDUCTIBLE by
        the corporation.

     3. Junior Stock Plans
        A type of restricted stock that is purchased at a price much lower than “regular” stock but can be
        converted into COMMON shares if performance goals are achieved. They are issued at a
        discount in value to common, but income is not recognized until the common shares are sold
        and then using LTCG rates. If the goals are not met, the company buys the junior shares back
        at the employee’s purchase price.
                    Keir Employee Benefits – Cardello Supplements

How funded plans are taxed under Section 83
Slide 74

       Section 83 requires that the FMV of the transferred property must be included in the employee’s
       income at ordinary income rates when the substantial risk of forfeiture EXPIRES. The amount
       includible as income by the employee is also DEDUCTED by the employer.

       1. Explain what is meant by a Section 83(b) election.
           Section 83(b) allows the employee to MAKE AN ELECTION to immediately be taxed on the
           receipt of the property at OI rates. However, any future appreciation won’t be taxed until the
           property is sold and then at LTCG rates. The election must be made within 30 days of
           receiving the property.

       2. Example:
           On October 1, 1998 Corporation ABC awards Taxpayer “X” 100 shares of its common stock.
           However, the stock is restricted in that “X” cannot transfer or sell it to anyone except ABC
           until October 1, 2002 when if she is still an employee of ABC all restrictions are removed and
           she can sell or transfer the shares to anyone. If “X” leaves ABC prior to that date she must
           sell the stock back to ABC for its October 1,1998 FMV of $5,000. Identify “X”’s income and
           ABC’s deduction assuming the FMV of the stock on October 1,2002 is $7,500.

           Case 1: “X” remains an employee and sells the stock on October 1, 2004 for $8,000.

                                   Grant                Restrictions         Sale
                                   Date:                Lifted:              Date:
                                   10-1-98              10-01-02             10-1-04

           “X”’s   LTCG

           “X”’s   OI

           “ABC” Deduction



           Case 2: Same facts as Case 1 except “X” makes a Section 83(b) election.

                                   10-1-98              10-01-02             10-1-04

           “X”’s   LTCG

           “X”’s   OI

           “ABC” Deduction
                    Keir Employee Benefits – Cardello Supplements

How funded plans are taxed under Section 83
Slide 74

       Section 83 requires that the FMV of the transferred property must be included in the employee’s
       income at ordinary income rates when the substantial risk of forfeiture EXPIRES. The amount
       includible as income by the employee is also DEDUCTED by the employer.

       1. Explain what is meant by a Section 83(b) election.
           Section 83(b) allows the employee to MAKE AN ELECTION to immediately be taxed on the
           receipt of the property at OI rates. However, any future appreciation won’t be taxed until the
           property is sold and then at LTCG rates. The election must be made within 30 days of
           receiving the property.

       2. Example:
           On October 1, 1998 Corporation ABC awards Taxpayer “X” 100 shares of its common stock.
           However, the stock is restricted in that “X” cannot transfer or sell it to anyone except ABC
           until October 1, 2002 when if she is still an employee of ABC all restrictions are removed and
           she can sell or transfer the shares to anyone. If “X” leaves ABC prior to that date she must
           sell the stock back to ABC for its October 1,1998 FMV of $5,000. Identify “X” ’s income and
           ABC’s deduction assuming the FMV of the stock on October 1, 2002 is $7,500.

           Case 1: “X” remains an employee and sells the stock on October 1, 2004 for $8,000.

                                   Grant                Restrictions         Sale
                                   Date:                Lifted:              Date:
                                   10-1-98              10-01-02             10-1-04

           “X”’s   LTCG                 0                   0                 $500     ($8,000-$7,500)

           “X”’s   OI                   0                $7,500                  0

           “ABC” Deduction              0                ($7,500)                0



           Case 2: Same facts as Case 1 except “X” makes a Section 83(b) election.

                                   10-1-98              10-01-02             10-1-04

           “X”’s   LTCG                 0                   0                $3,000 ($8,000- $5,000)

           “X”’s   OI               $5,000                  0                    0

           “ABC” Deduction          ($5,000)                0                    0
                 Keir Employee Benefits – Cardello Supplements

Golden Parachute Plan
No Slide

Describe a Golden Parachute Plan.
   A golden parachute plan is a compensation arrangement for TERMINATED executives when a
   corporation changes ownership or is taken over. If the payment qualifies as an “excess
   parachute payment” it will be NONDEDUCTIBLE by the employer and the executive is subject to
   a 20 percent excise tax in addition to regular income tax and FICA taxes. Congress sees these
   excess parachute payments as detrimental to shareholders.

   1. Define an excess parachute payment.
      An excess parachute payment is the amount that exceeds an allocated portion of the base
      amount based upon the present value of the current and aggregate parachute payments.
      That portion is figured by multiplying the base amount by a fraction, the numerator of which is
      the present value of such parachute payment and the denominator of which is the aggregate
      present value of all such payments. This can also be expressed in the following formula:

                                                   present value (PV) of payment
     Base amount allocable to payment =                                                      x base
                                                   aggregate PV of all payments

       Once classified as excess the penalty provisions apply to the ENTIRE excess. Payments
       from qualified pension, profit sharing, SIMPLE and SEP’s are not included.

   2. Example:

           Executive Karla, with a base amount of $100,000, expects two parachute
           payments, one of $200,000 at the time of the change in ownership and one of
           $400,000 at a future date. The present value of the $400,000 is $300,000 on the
           date ownership is changed.

           The portions of the base amount allocated to these base payments are:

           $100,000 x $200,000/$500,000 = $40,000, and

           $100,000 x $300,000/$500,000 = $60,000, respectively.

           Therefore, the amounts of Karla's excess parachute payments are:

           $200,000 - $40,000 = $160,000, and
           $400,000 - $60,000 = $340,000.

           Applying the 20 percent excise tax to those amounts, Karla must pay penalties of
           $32,000 and $68,000, respectively.

				
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