TOOLS & TECHNIQUES OF EMPLOYEE BENEFIT AND RETIREMENT PLANNING
11th Edition
College Course Materials
Deanna L. Sharpe, Ph.D., CFP®, CRPC®, CRPS®
Associate Professor
CFP® Program Director
Personal Financial Planning Department
University of Missouri-Columbia
Please Note: Correct answers for each question are indicated in bold type. After each question,
the number of the page containing information relevant to answering the question is given. When
a calculation is necessary or the reasoning behind a given answer may be unclear, a brief
rationale for the correct answer is also given.
Part B: Employee Benefit Planning
Equity Options
Chapter 35: Stock Option
True/False
35.1
Stock Option Plans must comply with nondiscrimination coverage rules.
35.2
An executive who receives a stock option must always include in his or her taxable income
the fair market value of the stock in the year the stock option was granted.
35.3
If a stock option has no readily ascertainable fair market value at the time it is transferred
to an executive, there is no taxable income to the executive at the date of the grant.
Answers:
35.1 False [p. 287]
35.2 False [pp. 288-89]
35.3 True [p. 288]
Multiple Choice
35.4
Disadvantages of a stock option include which of the following?
a.
b.
c.
d.
e.
employee bears market risk
market fluctuation may have little relationship with employee performance
employee must have source of funds to purchase stock
all of the above
only a and b
Answer: D [p. 287]
35.5
Which of the following is (are) true regarding the tax implications of a stock option that
does not have a readily ascertainable fair market value at the time of the grant?
a.
b.
c.
d.
e.
no taxable income to the employee at the date of the grant
employer receives a tax deduction at the time of the grant
employer receives a tax deduction when the employee exercises the option
a and b
a and c
Answer: E [pp. 288-89]
35.6
Which of the following is (are) true regarding the tax implications of a stock option that has
a readily ascertainable fair market value at the time of the grant?
a.
b.
c.
d.
e.
option is taxed at the time of the grant
employer receives a tax deduction at the time of the grant
employer receives a tax deduction when the employee exercises the option
a and b
a and c
Answer: D [pp. 288-89]
Application
35.7
The owners of Best Manufacturing are third generation members of the Best family and do
not want to share ownership of their closely held business. For day-to-day operations of
the business, the owners have a CEO and employees who are not related to the business.
Best is considering using a stock ownership plan to provide some additional reward for
their CEO after she led the company to record high earnings for 2 straight years, you
advise the owners that use of a stock option plan will
a. result in little out-of-pocket costs to Best Manufacturing
b. will allow Best Manufacturing to take a tax deduction in the year the stock option is
granted to the CEO
c. will give the CEO an ownership interest in the company
d. all of the above
e. only a and c
Answer: E [p. 287-88]
35.8
Executive Topdollar was given an option in 2007 to purchase 1,000 shares of Good
Company stock at $200 per share, the 2007 market price. Topdollar can exercise the
option anytime over the next 3 years. In 2009, Topdollar purchases 300 shares for a total
of $60,000. The fair market value of the shares in 2009 is $100,000. Which of the
following best describes the tax consequences of Topdollar’s stock option
a.
b.
c.
d.
e.
Good Company gets a tax deduction of $40,000 in 2007
Topdollar must pay ordinary income tax on $40,000
Topdollar must pay ordinary income tax on $60,000
a and b
a and c
Answer: D [p. 288 – The amount of taxable income for Topdollar is the difference between the fair
market value of the shares at the date of purchase and the option price ($100,000 - $60,000 =
$40,000. Good Company can take a tax deduction for when the option is exercised and shares are
purchased]
35.9
Executive Topdollar was given an option in 2007 to purchase 1,000 shares of Good
Company stock at $200 per share, the 2007 market price. In 2009, Topdollar purchases
300 shares for a total of $60,000. The fair market value of the shares in 2009 is $100,000.
Topdollar sold the 300 shares of stock in 2010 for $500 per share. Topdollar’s basis in the
shares acquired under his stock option plan is:
a.
b.
c.
d.
e.
$0
$40,000
$60,000
$100,000
$200,000
Answer: D [p. 288 – Topdollar’s basis is $60,000 paid for the shares + $40,000 of ordinary income
{calculated as $100,000 fair market value on date of purchase less $60,000option price} or
$100,000]
35.10 Hammond Publishing is a closely held company. The owner wants to keep the company in
the Hammond family. Hammond wants to attract an effective CEO to join the company
and cannot hire within the family to fill this position. Use of a stock option would help
Hammond accomplish all of their important objectives.
a. True
b. False
Answer: B [p. 287 – Hammond wants to keep the business in the family; transfer of stock to an
outside hire will dilute ownership]