Page 191 - Essentials of Payroll: Management and Accounting

ESSENTIALS of Payr oll: Management and Accounting
owns stock that has more than 10% of the total combined
voting power of all classes of stock of the employer.
• The option price at the time it is granted is not less than the fair
market value of the stock. However, it must be 110 percent of
the fair market value in the case of an option granted to an
employee who, at the time the option is granted, owns stock
that has more than 10 percent of the total combined voting
power of all classes of stock of the employer.
• The total value of all options that can be exercised by any one
employee in one year is limited to $100,000. Any amounts
exercised that exceed $100,000 will be treated as a nonquali-
fied stock option (to be covered shortly).
• The option cannot be transferred by the employee and can only be
exercised during the employee’s lifetime.

If the options granted do not include these provisions, or are granted
to individuals who are not employees under the preceding definition,
then the options must be characterized as nonqualified stock options.
A nonqualified stock option is not given any favorable tax treat-
ment under the Internal Revenue code (hence the name). It is also

referred to as a nonstatutory stock option. The recipient of an NSO does
not owe any tax on the date when options are granted, unless the
options are traded on a public exchange. In that case, the options can
be traded at once for value, and so tax will be recognized on the fair
market value of the options on the public exchange as of the grant
date. An NSO option will be taxed when it is exercised, based on the
difference between the option price and the fair market value of the
stock on that day. The resulting gain will be taxed as ordinary income.
If the stock appreciates in value after the exercise date, then the incre-

mental gain is taxable at the capital gains rate.
There are no rules governing an NSO, so the option price can be
lower than the fair market value of the stock on the grant date. The

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