Retire Ch 12 Deferred Comp, NQSO, ISO

Question 1

A stock option agreement must be in writing and must state an option term.

a. True b. False

Answer 1

a. True

Question 2

The exercise of an ISO triggers W-2 income for the employee.

a. True b. False

Answer 2

b. False

Question 3

At the exercise date of an NQSO, the employee will recognize W-2 income for the appreciation of the fair market value of the stock over the exercise price.

a. True b. False

Answer 3

a. True

Question 4

SARs are generally granted with NQSOs or ISOs, and may be used to provide cash to the executive to provide that executive with the cash necessary to exercise the NQSO or ISO.

a. True b. False

Answer 4

a. True

Question 5

Employee Stock Purchase Plans allow employees to use pre-tax dollars to purchase company stock at a discount.

a. True b. False

Answer 5

b. False

Question 6

A §83(b) election allows the employer to elect to include contributions to the deferred compensation plan into the employee’s income.

a. True b. False

Answer 6

b. False

Question 7

All of the following are reasons that an employer might favor a nonqualified plan over a qualified retirement plan except:

a. There is more design flexibility with a nonqualified plan.
b. A nonqualified plan typically has lower administrative costs.
c. Nonqualified plans typically allow the employer an immediate income tax deduction.
d. Employers can generally exclude rank-and-file employees from a nonqualified plan.

Answer 7

The correct answer is c.

Nonqualified plans do not allow the employer to take an income tax deduction until the employee recognizes the income. All of the other statements are correct.

Question 8

Tyree has an 18% nonqualified deferred compensation plan that is funded annually by his employer. Payments are made to a separate trustee of a secular trust who was selected by Tyree and his employer. The employer contributions are discontinued at Tyree’s death, disability, or employment termination. When Tyree retires or terminates employment, he will receive the proceeds from the trust.
Which of the following is/are correct regarding the deferred compensation plan?

1. The contributions are not currently taxable to Tyree because they are subject to a substantial risk of forfeiture.
2. The contributions to the plan are currently subject to payroll taxes.
3. The employer can deduct the contributions to the plan at the time of the contribution.

a. 3 only.
b. 1 and 3.
c. 2 and 3.
d. 1, 2, and 3.

Answer 8

The correct answer is c.

Because this arrangement is a secular trust, there is no substantial risk of forfeiture to Tyree.

Thus,Statement 1 is false. Because the trust is not subject to the general creditors of the employer, this is straight compensation.

Tyree must treat the payments as constructively received, and the employer may deduct the payments as compensation immediately.

The payments are subject to payroll tax since the compensation is currently earned

Question 9

Courtney receives stock options for 12,000 shares of XYZ Corporation with an exercise price of $10 when the stock is trading on the national exchange for $10 per share. The XYZ company plan is an incentive stock option plan.
Which of the following statements are true regarding the options?

1. Courtney will be required to hold any ISOs for more than a year after exercise and more than two years from the grant date to have long-term capital gains.
2. 2,000 of the options are NQSOs.

a. 1 only.
b. 2 only.
c. Both 1 and 2.
d. Neither 1 nor 2.

Answer 9

The correct answer is c.

To the extent the fair market value of the stock for which the ISO is exercisable for the first time during any calendar year exceeds $100,000, the excess is treated as a nonqualified stock option.

Therefore, 2,000 of the options are NQSOs

Question 10

Kurt receives stock options (ISOs) with an exercise price of $18 when the stock is trading at $18. Kurt exercises these options two years after the date of the grant when the stock price is $39 per share. Which of the following statements is correct?

a. Upon exercise Kurt will have no regular income for tax purposes.
b. Kurt will have W-2 income of $21 per share upon exercise.
c. Kurt will have $18 of AMT income upon exercise.
d. Kurt’s adjusted basis for regular income tax will be $39 at exercise.

Answer 10

The correct answer is a.

Kurt does not have income at the date of exercise.

Kurt’s adjusted basis will be $18.

The AMT income is equal to the difference between the fair market value and the exercise price

($39-$18=$21).

Question 11

Brynn received 1,000 NQSOs with an exercise price of $25 per share when the stock was $25 on the market. Two years from the date of grant Brynn exercises when the stock price is $102.

At exercise, Brynn: has what ?

a. Has W-2 income of $25,000.
b. Has W-2 income of $77,000.
c. Has an AMT adjustment of $25,000.
d. Has an AMT adjustment of $77,000.

Answer 11

The correct answer is b.

Brynn will have W-2 income of the difference between the market price and the exercise price ($102 -$25 x $1,000 = $77,000).

She will not have an AMT adjustment for the exercise of an NQSO

Question 12

Cindy Sue has been with CS Designs, Inc. for five years. CS Designs has a deferred compensation plan to provide benefits to key executives only. CS Designs contributed $400,000 into a trust for Cindy Sue’s benefit under the company’s deferred compensation plan. The plan requires that executives must work for the company for 10 years before any benefits can be obtained from the plan. Cindy Sue has come to you to determine when she will be subject to income tax on the contribution by the employer.
Which of the following is correct?

Since the assets were placed into a trust, the economic benefit doctrine will require inclusion in income for the current year contributions made by the employer.

Since Cindy Sue cannot receive the benefits until she has been with the employer for 10 years, the substantial risk of forfeiture doctrine will not require inclusion in income for the current year contributions made by the employer.

Since the assets were placed into a trust, the constructive receipt doctrine will require inclusion in income for the current year contributions made by the employer.

Cindy Sue is subject to income tax in the current year because the plan is discriminatory.

Answer 12

Since Cindy Sue cannot receive the benefits until she has been with the employer for 10 years, the substantial risk of forfeiture doctrine will not require inclusion in income for the current year contributions made by the employer.

Rationale

The economic benefit and constructive receipt doctrines will not cause inclusion because the assets are forfeitable if she does not stay the required length of service.

Deferred compensation plans are by nature discriminatory.

The contributions will be included if the employee has an economic benefit, no risk of forfeiture, or constructive receipt.

Question 13

ABC has an Employee Stock Purchase Plan (ESPP). Which statement(s) regarding an ESPP is/are correct?

1. The purchase price of the stock may be as low as 85% of the stock value.
2. When an employee sells ESPP stock at a gain in a qualifying disposition, all of the gain is capital gain.
3. There is an annual limit of $25,000 per employee for ESPPs.

1 only.
1 and 2.
1 and 3.
2 and 3.

Answer 13

1 and 3.

Rationale

Statement 2 is incorrect because only the gain in excess of the W-2 income (on the bargain amount) will be capital gain.

Statements 1 and 3 are correct.

Question 14

Which of the following is false regarding a deferred compensation plan that is funded utilizing a rabbi trust?

1. Rabbi trusts provide participants with security against the employer’s unwillingness to pay.
2. Rabbi trusts provide participants with security against employer bankruptcy.
3. Rabbi trusts provide tax deferral for participants.
4. Rabbi trusts provide the employer with a current tax deduction.

None, they are all true.
2 and 4.
1, 2, and 4.
1, 2, 3, and 4

Answer 14

2 and 4.
Rationale

Rabbi trusts do not provide security against employer bankruptcy or a current tax deduction for the employer.

Question 15

Brynn received 1,000 NQSOs with an exercise price of $25 per share when the stock was $25 on the market.
Two years from the date of grant, Brynn exercises when the stock price is $102.

At exercise, Brynn:

Has W-2 income of $25,000.
Has W-2 income of $77,000.
Has an AMT adjustment of $25,000.
Has an AMT adjustment of $77,000.

Answer 15

Has W-2 income of $77,000.

Rationale

Brynn will have W-2 income of the difference between the market price and the exercise price ($102 - $25 x $1,000 = $77,000).

She will not have an AMT adjustment for the exercise of an NQSO.

Question 16

Which of the following is true regarding employer contributions to secular trusts for employee-participants of a nonqualified deferred compensation agreement?

1. Participants have security against an employer’s unwillingness to pay at termination.
2. Participants have security against an employer’s bankruptcy.
3. Secular trusts provide tax deferral for employees until distribution.
4. Secular trusts provide employers with a current income tax deduction.

3 only.
1 and 2.
1, 2, and 4.

Answer 16

1, 2, and 4.
Rationale

Secular trusts are similar to rabbi trusts except that participants do not have a substantial risk of forfeiture and thus, do not provide the employee with tax deferral.
Secular trusts provide the employer with a current income tax deduction for contributions.
Secular trusts protect the participant from employer unwillingness to pay because they are funded and they protect from bankruptcy because there is no risk of forfeiture.

Question 17

Courtney receives stock options for 12,000 shares of XYZ Corporation with an exercise price of $10 when the stock is trading on the national exchange for $10 per share. The XYZ company plan is an Incentive Stock Option Plan.

Which of the following statements are true regarding the options?

1. Courtney will be required to hold any ISOs for more than a year after exercise and more than two years from the grant date to have long-term capital gains.
2. 2,000 of the options are NQSOs.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 17

Both 1 and 2.

Rationale

To the extent the fair market value of the stock for which the ISO is exercisable for the first time during any calendar year exceeds $100,000, the excess is treated as a nonstatutory stock option. Therefore, 2,000 of the options are NQSOs.

Question 18

Tucker was awarded 1,000 shares of restricted stock of B Corp at a time when the stock price was $14. Assume Tucker properly makes an 83(b) election at the date of the award. The stock vests 2 years later at a price of $12 and Tucker sells it then.
What are Tucker’s tax consequences in the year of sale?

Tucker has W-2 income of $12,000.
Tucker has a long-term capital loss of $2,000.
Tucker has W-2 income of $14,000.
Tucker has a $12,000 long-term capital gain.

Answer 18

Tucker has a long-term capital loss of $2,000.

Rationale

In the year of sale, Tucker will have a long-term capital loss of $2,000 ($14,000 - $12,000) because his right to the stock vested.

When 83(b) is elected, losses are permitted after the right to the stock has vested.

Question 19

Jennifer received 1,000 SARs at $22, the current trading price of Clippers, Inc., her employer. If Jennifer exercises the SARs three years after the grant and Clipper’s stock is $34 per share, which of the following statements is true?

Jennifer will have an adjusted basis of $22,000 in the Clippers, Inc. stock.

Jennifer will have W-2 income equal to $12,000.

Jennifer will have long-term capital gain of $12,000.

Jennifer will have ordinary income equal to $22,000.

Answer 19

Jennifer will have W-2 income equal to $12,000.

Rationale

At the exercise of a SAR, the employee receives the difference between the fair market value and the exercise price as W-2 income. Thus, Jennifer has W-2 income equal to $12,000 [($34-$22)x1,000].

Question 20

UPDATED FOR 2024:

On July 31, 2017, B Corp sold 1,000 shares of its stock to Barry, an employee, for $12 per share. At the time of the sale, B stock was trading for $30 per share. The stock was to vest in 7 years on July 31, 2024. This restriction was stamped on the certificates. On July 31, 2024, the B stock was trading for $125 per share. Barry sold the stock in September 2025 for $150 per share.
Assuming no special elections, how much must Barry include in income and in what year?

Option Year Amount
A 2017 $18,000
B 2017-2024 Ratable gain based on year-end value
C 2024 $113,000
D 2025 $113,000

Option A.
Option B.
Option C.
Option D.

Answer 20

Option C.

Rationale

When the substantial risk of forfeiture expires on July 31, 2024, Barry has income of $125,000 less the adjusted basis of $12,000, or $113,000.
Barry will also have a gain of $25 per share from the date the stock vested until he sells the stock.

Question 21

Which of the following are characteristics of a phantom stock plan?

1. Benefits are paid in cash.
2. There is no equity dilution from additional shares being issued.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2

Answer 21

Both 1 and 2.
Rationale

The employee does not actually receive stock in a phantom plan. Instead, the employee receives credits for the stock and the benefits are later paid in cash.

Question 22

In 2024, Mario, an accomplished professional race car driver, is to receive a signing bonus for agreeing to drive for Hot-Lap International, a racing team. Hot-Lap agrees to establish a NQDC agreement with Mario to defer the bonus beyond Mario’s peak income producing years. Hot-Lap transfers the bonuses to an escrow agent, subject to the risk of forfeiture to team creditors in bankruptcy, who invests the funds in securities acting as a hedge against inflation. The bonus is deferred until 2025 and is then paid to Mario in years 2025-2035.
When is the income deductible by the employer and includible by Mario?

Option Employer
Deduction Employee
Inclusion
A 2024 2024
B 2025 2025
C 2025-2035 2025
D 2025-2035 2025-2035
Option A.
Option B.
Option C.
Option D.

Answer 22

Option D.
Rationale

The income is only deductible when includible by Mario in 2025-2035.

Question 23

Tyree has an 18% nonqualified deferred compensation plan that is funded annually by his employer. Payments are made to a separate trustee of a secular trust who was selected by Tyree and his employer. The employer contributions are discontinued at Tyree’s death, disability, or employment termination. When Tyree retires or terminates employment, he will receive the proceeds from the trust.

Which of the following is/are correct regarding the deferred compensation plan?

1. The contributions are not currently taxable to Tyree because they are subject to a substantial risk of forfeiture.
2. The contributions to the plan are currently subject to payroll taxes.
3. The employer can deduct the contributions to the plan at the time of the contribution.

3 only.
1 and 3.
2 and 3.
1, 2, and 3

Answer 23

2 and 3.

Rationale

Because this arrangement is a secular trust, there is no substantial risk of forfeiture to Tyree.

Thus, Statement 1 is false. Because the trust is not subject to the general creditors of the employer, this is straight compensation.

Tyree must treat the payments as constructively received, and the employer may deduct the payments as compensation immediately. The payments are subject to payroll tax since the compensation is currently earned

Question 24

All of the following are reasons that an employer might favor a nonqualified plan over a qualified retirement plan except:

There is more design flexibility with a nonqualified plan.
A nonqualified plan typically has lower administrative costs.

Nonqualified plans typically allow the employer an immediate income tax deduction.

Employers can generally exclude rank-and-file employees from a nonqualified plan.

Answer 24

Nonqualified plans typically allow the employer an immediate income tax deduction.
Rationale

Nonqualified plans do not allow the employer to take an income tax deduction until the employee recognizes the income. All of the other statements are correct.

Question 25

Arnie, the CEO of The Producers Inc., was awarded the following stock options from The Producers Inc.
Option Grant
Date Type Exercise
Price FMV Number of
Shares
1 1/1/2019 NQSO $15 $15 1,000
2 1/1/2024 NQSO $25 $25 1,000

During 2024, Arnie had the following transactions regarding the above options.
Option Date Action Number of
Options (O) /
Shares (S) Market Price
on Date
1 2/1/2024 Exercised 1,000 (O) $27
1 2/1/2024 Sold 1,000 (S) $27
2 12/12/2024 Exercised 1,000 (O) $36

Which of the following is correct?

Arnie has $11,000 of W-2 income and a $12,000 capital gain.
Arnie has $23,000 of W-2 income.
Arnie has capital gain of $12,000.
Arnie has $66,000 of W-2 income.

Answer 25

Arnie has $23,000 of W-2 income.

• At the exercise of an NQSO,
  FMV 27,000
• Exercise Price -15,000
  W-2 Income 12,000At exercise of option 0 has FMV $ 36,000
  - exercise $ 25,000
  w-2 income = 11,000

     $12,000 + $11,000 = $23,000  ( W-2 income equal to the excess of the fair market value over the exercise price. )

• In this problem, Arnie has $12,000 [($27-$15)x1,000] of W-2 income related to the 1/1/2018 options and $11,000 [($36-$25)x1,000] of W-2 income related to the 1/1/2023 options.

Question 26

Kurt receives stock options (ISOs) with an exercise price of $18 when the stock is trading at $18. Kurt exercises these options two years after the date of the grant when the stock price is $39 per share.

Which of the following statements is correct?

Upon exercise Kurt will have no regular income for tax purposes.
Kurt will have W-2 income of $21 per share upon exercise.
Kurt will have $18 of AMT income upon exercise.
Kurt’s adjusted basis for regular income tax will be $39 at exercise.

Answer 26

Upon exercise Kurt will have no regular income for tax purposes.
Rationale

Kurt does not have income at the date of exercise.

Kurt ’s adjusted basis will be $18.

The AMT income is equal to the difference between the fair market value and the exercise price ($39 - $18 = $21).

Question 27

Rick has an 18% nonqualified deferred compensation plan that is funded annually by his employer. Payments are made to a separate trustee of a secular trust who was selected by Rick and his employer. The employer contributions are discontinued at Rick’s death, disability, or employment termination. When Rick retires or terminates employment, he will receive the proceeds from the trust.
Which of the following is/are correct regarding the deferred compensation plan?

The contributions are not currently taxable to Rick because they are subject to a substantial risk of forfeiture.

The contributions to the plan are currently subject to payroll taxes.
The employer can deduct the contributions to the plan at the time of the contribution.

A.3 only
B.1 and 3
C.2 and 3
D.1, 2, and 3

Answer 27

The correct answer is C.

Because this arrangement is a secular trust, there is no substantial risk of forfeiture

. Thus, Statement 1 is false.

Because the trust is not subject to the general creditors of the employer, this is straight compensation.

Rick must treat the payments as constructively received, and the employer may deduct the payments as compensation immediately.

The payments are subject to payroll tax since the compensation is earned.

Question 28

ABC has an Employee Stock Purchase Plan (ESPP). Which statements regarding an ESPP are correct?

The price may be as low as 85% of the stock value.

When an employee sells stock at a gain in a qualifying disposition, all of the gain will be capital gain.

There is an annual limit of $25,000 per employee.

A.1 only
B.1 and 2
C.1 and 3
D.2 and 3

Answer 28

solution: The correct answer is C.

Statement 2 is incorrect because only the gain in excess of the W-2 income will be capital gain.

Question 29

Biks, Inc grants Janie 1 ISO on Jan 1, 20X1. The exercise price is $10. The market price on the exercise date (Jan 1, 20X3) is $25. Janie sold the stock on July 1, 20X3 for $200.

What are the tax consequences when Janie sells the stock?

A.$15 W-2 income
B.$190 capital gain
C.$15 W-2 income; $175 capital gain
D.$175 capital gain

Answer 29

Solution: The correct answer is C.

W-2 income – 25-10 = 15

ST Capital Gain = 200 – 25 = 175

Question 30

Biks, Inc grants Janie 1 NQSO on Jan 1, 20X1. The exercise price is $10. The market price on the exercise date (Jan 1, 20X3) is $25. Janie sold the stock on July 1, 20X3 for $100. What are the tax consequences when Janie sold the stock?

A.$15 of W-2 income
B.$75 of short term gain
C.$75 of long term gain
D.$90 of W-2 income

Answer 30

Solution: The correct answer is B.

On Jan 1, 20x3

Mkt price – 25

Exercise Price – 10

Gain – 15 – w-2 income

On July 1, 20x3

Market Price – 100

Basis – 25

Gain – 75 – short term