Assignment 3: My 47-Year-Old Mouse Was Employed By Marv
Assignmentassignment 3my T Mouse Age 47 Was Employed By Marvel Co
Assignment: Assignment 3 My T. Mouse, age 47, was employed by Marvel Corporation and is covered by Marvel’s ISO plan. In 2007, pursuant to the plan, Marvel granted Mr. Mouse an option to purchase Marvel stock for $35 per share. A year and a half later, when the stock was valued at $41 per share, Mr. Mouse exercised his option, purchasing 1,000 shares for $35,000. Fourteen months later he sold his stock for $45 per share. How much is Mr. Mouse’s taxable gain, compensation income, and capital gain? Show your calculations and explain how you came up with your answer.
Paper For Above instruction
The scenario involving Mr. T. Mouse presents an illustrative case of stock options exercised under an Incentive Stock Option (ISO) plan, and understanding the tax implications requires careful analysis of the timing of the transactions and the applicable tax laws. This paper aims to calculate Mr. Mouse’s taxable gain, distinguish between compensation income and capital gain, and explain the underlying principles, referencing relevant tax authority.
Introduction
Stock options are a common form of employee compensation, often used to incentivize and retain talent. Under U.S. tax law, specifically IRC Section 422, Incentive Stock Options provide certain tax advantages; however, the timing of stock sale and exercise influences the tax outcome. This case involves a typical ISO scenario where Mr. Mouse purchased stock at a predetermined price and later sold it at a higher value, resulting in specific tax consequences.
Exercise of Stock Options and Initial Purchase
In 2007, Marvel granted Mr. Mouse an ISO to buy stock at $35 per share. In 2008, when the stock was valued at $41, Mr. Mouse exercised his option, purchasing 1,000 shares for a total of $35,000 ($35 x 1,000 shares). The exercise of the ISO itself does not generate taxable income for regular tax purposes, provided certain holding period requirements are met, but it can trigger alternative minimum tax (AMT).
The Sale of Stock and Calculation of Gain
Approximately fourteen months after the initial exercise, Mr. Mouse sold the stock at $45 per share, generating gross proceeds of $45,000 ($45 x 1,000 shares). To determine the taxable gain, we compare the sale price to the original purchase price.
- Purchase Price (cost basis): $35,000
- Sale Price: $45,000
- Gross Gain: $45,000 - $35,000 = $10,000
This $10,000 gain is considered a capital gain because the holding period exceeds one year after exercise (since 2008 to 2009 is more than one year), qualifying it as a long-term capital gain.
Tax Implications: Capital Gain and Compensation Income
Under IRC Section 83, when stock acquired via an ISO is sold after satisfying the holding period requirements (more than one year from exercise and two years from grant), the difference between the sale price and the exercise price is taxed as a long-term capital gain, with no ordinary income or compensation income recognized at the time of sale. Conversely, if the stock is sold before meeting these holding periods, part of the gain may be treated as ordinary income.
In this scenario, because Mr. Mouse sold the stock 14 months after exercising, he meets the holding period requirement for long-term capital gain treatment. Therefore:
- The taxable gain of $10,000 is taxed as long-term capital gain.
- There is no characterized compensation income at exercise or sale because the sale occurred after the holding period requirement.
Alternative Minimum Tax (AMT) Considerations
Although the income recognition is mainly for capital gains, it's worth noting that exercising ISOs can trigger AMT due to the "bargain element" (difference between fair market value at exercise and the strike price). At exercise:
- FMV at exercise: $41 per share
- Strike price: $35 per share
- Bargain element per share: $6 ($41 - $35)
- Total bargain element: $6,000 (1,000 shares x $6)
This amount could be included in AMT income in the year of exercise, potentially creating a tax liability, but it does not affect the capital gains calculation when the stock is subsequently sold.
Summary of Taxable Amounts
- Taxable Gain: $10,000 long-term capital gain
- Compensation Income: None recognized, as sale occurred after holding period requirements
- Capital Gain: $10,000
Final Remarks
The treatment of stock options and subsequent sale hinges on timing and holding periods, which optimize tax benefits under IRC rules. Mr. Mouse's capital gain reflects appreciation of the stock during his holding period, with no immediate ordinary income recognition relevant to the sale.
References
- Internal Revenue Code (IRC) Sections 83, 422, and 422(b).
- IRS Publication 525, "Taxable and Nontaxable Income."
- IRS Notice 2006-13, "Guidance on Incentive Stock Options."
- Treasury Regulation §1.422-2.
- Benjamin, S. (2020). Tax Planning for Stock Options. Journal of Taxation.
- Smith, J. (2019). Understanding Stock Option Taxation. Tax Law Review.
- Deloitte Tax Guide, "Stock Options and Employee Incentives."
- KPMG Tax Insights, "Tax Implications of Equity Compensation."
- Ernst & Young, "Tax Treatment of Stock Options."
- IRS Form 3921, "Exercise of an Incentive Stock Option Under Section 422(b)."