| In this type, the option price can be set at any | | | | used to pay the withholding costs. If his profits |
| amount and the option can be exercised at any | | | | from the exercise are substantial, some |
| time, limited only by what the stockholders of the | | | | preplanning should be done to consider where he |
| company will approve. In a rising market, an | | | | will get the funds to pay additional taxes when he |
| executive can make a substantial profit. | | | | files his tax returns. |
| It is true, of course, that the executive must pay | | | | If he sells the stock sometime in the future for $ |
| ordinary income tax on the difference between | | | | 100 per share, he owes no taxes. However, if he |
| the option price and the stock's fair market value | | | | thinks that the value of Americana stock is likely |
| at the time the option is granted. If the option is | | | | to rise due to its current success and future |
| subject to a condition that affects its value, | | | | plans, he may want to exercise his options sooner |
| there's no taxation until the condition is met or | | | | rather than later. Why? Because though he'll pay |
| removed. | | | | ordinary income tax and withholding costs on any |
| Again, let's look at some actual figures. Suppose | | | | positive difference between his exercise price and |
| Corporation Americana agrees to give Mr. Key an | | | | the stock's fair market value at the time, any |
| option to buy 1,000 shares of Americana stock at | | | | future increase in the value of the stock can be |
| $50 per share. The agreement states that Key | | | | taxed at the more favorable capital gains rate. If |
| can exercise the option in four installments of two | | | | he can afford to tie down his money while he |
| hundred fifty shares per year, starting one year | | | | waits for this increase, has the money to pay the |
| from the date of the agreement. There is a | | | | income tax and withholding costs on his exercise, |
| further condition that Mr. Key must still be | | | | and considers it a priority investment, this could |
| employed by Americana at the time he exercises | | | | be a good strategy for him. |
| each of the installments. | | | | As if this were not enough for Mr. Key to think |
| At the time Key is given the option the market | | | | about, he should also evaluate how much of his |
| value of the stock is $75 per share. At the end | | | | own net worth is tied up in Americana's stock. |
| of the first year, it goes up to $100 and Mr. Key | | | | The issue of diversification and how much he |
| exercises the first installment, paying the | | | | wants to depend on the future growth and |
| company $12,500 for 250 shares. On paper, he | | | | stability of Corporation Americana should be |
| now has a profit of $12,500. This is the value of | | | | considered. If his stock exercise is dependent |
| the first installment of the option, and therefore | | | | upon his working at Americana at the time of |
| he must pay ordinary income tax on this sum. Mr. | | | | exercise, he may want to evaluate his own |
| Key will also be subject to federal income tax | | | | prospects for staying on board at Americana. |
| withholding, social security, Medicare, state and | | | | To the corporation, the taxation aspects of |
| local taxes at the time of exercise. (Some | | | | unrestricted options are more advantageous. It |
| employers have written in provisions to allow the | | | | gets a tax deduction for the value of what it |
| use of shares to cover withholding costs.) If Mr. | | | | gives the executive: the difference between the |
| Kay exercises his stock option, then sells the | | | | option price and the market price at the time the |
| stock soon thereafter, his cash proceeds can be | | | | option becomes taxable to the employee. |