upon exercise of the stock options are sold.
Employment income inclusion is calculated as follows:
(the company's stock price at time of exercise - the exercise price) x
the number of options exercised
You would not have to report this employment income until the shares
are sold as stated earlier.
Using your numbers (15-10) x 1,000 = $5,000 would be your income
inclusion which is delayed until you sell the shares.
Your basis for the shares is $15 x 1,000 = $15,000.
If the shares are disposed of for more than $15 then there is a
capital gain. If the shares are sold at less than $15 then there is a
If the stock gets sold >= $15 you are fine, however, if the stock
drops then you have to pay tax at ordinary income rates not the more
attractive capital gain rates for the (15-10) x 1000 even though you
didn't actually benefit from the stock at $15.
You have to think about the stock price. It is easy to see it
improving but if it drops then you paid tax when you didn't really get
anything out of it. So, supposed the stock tanked. You would have
paid income tax on $5,000 and will not be able to ever get it back.
If you are a normal investor and buy stock then you buy the stock and
any losses are capital losses so you can offset other capital gains,
but since the income inclusion is given the character of ordinary
income this is not possible - ordinary losses cannot offset capital
So, if you exercise the options and purchase the shares and then the
stock drops then you are basically taking a hit on the income tax you
paid on the income tax you paid on the income inclusion of (15-10) x
1000. The stock suppose it drops to $2 then you will have a capital
loss of ($15-2) x 1000 = $13,000 which you can offset capital gains.
This is hard to explain. The key thing to remember is that the income
inclusion is not capital income and cannot offset capital losses. So,
the income inclusion is the piece of the puzzle that has the risk.