Page 430 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

416 The Complete Guide to Executive Compensation

non-management members of the board of directors. A few companies have also made stock
option grants to suppliers, such as consultants. Some innovative companies may also include
major customers, bonding them further to the organization.

Grant Transfer. Many options do not permit transferring or pledging ownership to anyone
else. However, some companies (in their grant) give the optionee the right to transfer a non-
statutory option, while living, to a family member. Some executives find it advantageous to
pay a gift tax on the option before it has increased in value enough to draw an estate tax at
time of death. However, the transfer does not also transfer income tax liability to the new
optionee during the executive’s lifetime. Several issues need to be addressed. First, is the gift
complete for taxation purposes when transferred or when vested? Secondly, what is the basis
for valuing the transfer—spread between fair market value and option price, or some type of
present-value modeling? The IRS has ruled on both of these issues. Revenue Ruling 98-21
states that a gift is not complete until the option is vested. Revenue Ruling 98-24 adds that a
pricing model such as Black-Scholes should be used in determining the value of a vested
option that has been transferred.
Table 8-8 illustrates who has a taxable event (and when) with a transferred stock
option. Recall that there is an annual $12,000 exclusion ($24,000 if joint with spouse).
Amounts exceeding the annual exclusion would apply to the annual lifetime exclusion
maximum. Gifts in excess of this amount would draw gift tax in the year in which the gift
was made.

Is Event Taxable at Time of:
Grant Gift Exercise Sale

Transferor
Gift tax No Yes No No

Estate tax No No No No
Income tax No No Yes No

Transferee
Gift tax No No No No

Estate tax No No No No
Income tax No No No Yes

Table 8-8. Type and timing of transferred stock option taxation

Another form of transfer is permitting the optionee to sell the option to a third party
(e.g., a financial institution). This might be a one-time event (which may be attractive if
the stock option is underwater) or an ongoing feature of the plan permitted each quarter
during designated periods. These need to be examined carefully in light of FASB, IRS, and
SEC requirements.