Orange Incorporated issued 28,500 nonqualified stock options valued at $57,000 (in total). The options vest over two years-half in 2020 (the year of issue)and half in 2020. One thousand options are exercised in 2021 with a bargain element on each option of $7. What is the 2021 book-tax difference associated with the stock options?

Question

Quizplus · Accepted Answer

To calculate the book-tax difference associated with stock options, we must first determine the compensation expense associated with the options. Since the options vest over two years, we can calculate the annual compensation expense as follows:

Annual compensation expense = Total options value / Vesting period
Annual compensation expense = $57,000 / 2 = $28,500

Therefore, the compensation expense associated with the 1,000 options exercised in 2021 is $28,500.

The tax deduction for nonqualified stock options is equal to the bargain element (the difference between the fair market value of the stock on the exercise date and the exercise price) multiplied by the number of exercised options. In this case, the bargain element is $7 per option, and thus the tax deduction is $7,000.

The book-tax difference is the difference between the compensation expense and the tax deduction. Therefore, the book-tax difference is:

Book-tax difference = Compensation expense - Tax deduction
Book-tax difference = $28,500 - $7,000 = $21,500 unfavorable.

Orange Incorporated Issued 28,500 Nonqualified Stock Options Valued at $57,000