ExpertMedium1 markMultiple Choice
CPA · Question 01 · Area I: Individual Compliance and Planning
In Year 1, an executive receives an Incentive Stock Option (ISO) to purchase 1,000 shares of stock at $10 per share (FMV at grant). In Year 2, when the stock FMV is $25, the executive exercises the option. In Year 3, the executive sells the stock for $35 per share. Assume the executive meets all holding period requirements for ISO treatment. What are the tax consequences in Year 2?
In Year 1, an executive receives an Incentive Stock Option (ISO) to purchase 1,000 shares of stock at $10 per share (FMV at grant). In Year 2, when the stock FMV is $25, the executive exercises the option. In Year 3, the executive sells the stock for $35 per share. Assume the executive meets all holding period requirements for ISO treatment. What are the tax consequences in Year 2?
Answer options:
A.
Ordinary income of $15,000 for regular tax purposes.
B.
No regular tax income is recognized, but $15,000 is an adjustment for AMT purposes.
C.
Capital gain of $15,000 for regular tax purposes.
D.
No tax consequences for either regular tax or AMT.
How to approach this question
Distinguish between ISO and NSO rules. For ISOs, the exercise event is a non-event for regular tax (if holding periods are met) but triggers an AMT adjustment equal to the spread between FMV and exercise price.
Full Answer
B.No regular tax income is recognized, but $15,000 is an adjustment for AMT purposes.✓ Correct
Under IRC §421 and §56(b)(3), the exercise of an ISO does not trigger regular taxable income if statutory requirements are met. However, the spread between the fair market value at exercise ($25) and the exercise price ($10) is an adjustment for Alternative Minimum Tax (AMT) purposes in the year of exercise.
Common mistakes
Confusing ISOs with NSOs; forgetting the AMT implication of ISO exercise.
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