Chapter 12 Compensation Discussion Questions: 1. [LO 1] Nicole and Braxton are each 50 percent shareholders of NB Corporation. Nicole is also an employee of the corporation. NB is a calendar-year taxpayer and uses the accrual method of accounting. The corporation pays its employees monthly on the first day of the month after the salary is earned by the employees. What issues must NB consider with respect to the deductibility of the wages it pays to Nicole if Nicole is Braxton’s sister? What issues arise if Nicole and Braxton are unrelated? If Nicole and Braxton are sister and brother, according to §267(b) of the Internal Revenue Code, Nicole and NB Corporation are considered to be “related persons.” Nicole is treated as owning her 50 percent and her brother’s 50 percent for a total of 100 percent ownership. Because NB and Nicole are related, NB is not allowed to deduct the salary expense it accrued for book purposes on the salary it owes to Nicole until the year in which Nicole recognizes income. This does not cause any issues until the last paycheck of the year. For book purposes, NB accrues and deducts Nicole’s December salary but for tax purposes, NB is not able to deduct the salary until January 1 when Nicole receives her check. If Nicole and Braxton are unrelated, Nicole would own 50 percent of NB, and she would not be considered a related party to NB because she does not own more than 50 percent of NB. NB is allowed to deduct the compensation earned by Nicole in December of the prior year as long as it pays the compensation within 2 ½ months of year end (by March 15). In this case, NB pays the compensation at the beginning of January, so it would be allowed to deduct the compensation expense it accrued in December for Nicole. 2. [LO 1] Holding all else equal, does an employer with a higher marginal tax rate or lower marginal tax rate have a lower after-tax cost of paying a particular employee’s salary? Explain. Holding all else equal (including the amount of the employee’s salary) an employer with a higher marginal tax rate will have a lower after-tax cost of paying an employee’s salary. The reason is that the employer’s after-tax cost of the salary is the before tax cost minus the tax savings from deducting the employee’s salary. The tax savings from a deduction are greater the higher the marginal tax rate. Because the high marginal tax rate employer has greater tax savings from deducting the employee’s salary, the high marginal tax rate employer has a lower after-tax cost of paying the employee’s salary. 3. [LO 1] What nontax reasons explain why a corporation may choose to cap its executives’ salaries at $1 million? A corporation may choose to cap its executives’ salaries at $1 million, even if it is not concerned about the loss of the tax deduction, to send a signal to shareholders. Not exceeding the limit signals to the shareholders that the corporation is being fiscally responsible by (1) not overpaying executives, and (2) ensuring that all compensation paid to executives is tax deductible. 4. [LO 1] What tax reasons explain why a corporation may choose to cap its executives’ salaries at $1 million? Publicly-traded corporations may cap their executives’ salaries at $1 million to ensure that the company is able to deduct the compensation expense for the full amount of the compensation. This is important because the government no longer subsidizes salary for covered employees over $1 million. This means for a corporation with a 21 percent marginal tax rate that the government would effectively be paying $210,000 for the first $1 million in salary. However, for publicly-traded corporations, the deductible compensation limit for covered employees is $1 million. The definition of covered employees is the CEO, CFO, and of the other three highest compensated officers (plus all covered employees from prior years). Consequently, the government does not subsidize this excess salary which makes the salary above $1 million more expensive to provide, on an after-tax basis, than salary up to $1 million. 5. [LO 2] From an employee perspective, how are ISOs treated differently than NQOs for tax purposes? In general, for a given number of options, which type of stock options should employees prefer? Unlike nonqualified stock options, the bargain element of incentive stock options is not included in the employee’s regular taxable income on the exercise date. Instead, the bargain element present on the exercise date is deferred until the stock acquired from the option exercise is sold—assuming the employee meets the holding period required to become an incentive stock option (at least two years after grant date and one year after exercise date). Further, with incentive stock options, the bargain element is treated as long-term capital gain rather than ordinary income when the stock is sold. For these reasons, employees generally prefer incentive stock options over an equivalent number of nonqualified options. 6. [LO 2] From an employer perspective, how are ISOs treated differently than NQOs for tax purposes? In general, for a given number of options, which type of stock options should employers prefer? In contrast to nonqualified options, employers never receive a deduction for incentive stock options. Thus, employers generally prefer to issue (unless the employer’s marginal rate is 0 percent) nonqualified options over an equivalent number of incentive stock options. 7. [LO 2] Why do employers use stock options in addition to salary to compensate their employees? For employers, are stock options treated more favorably than salary for tax purposes? Explain. Because stock options reward employees for making choices that increase the share price of the corporations where they are employed, this form of compensation is considered to be superior to salary in terms of motivating employees to behave more like owners—in short, stock options align the incentives of employees and owners. In addition, employers may use stock options to compensate their employees without a cash outlay. For tax purposes, NQOs are treated the same as salary and wages. The employer receives a deduction equal to the bargain element (FMV of shares on exercise date less the strike price). In certain situations, NQOs can potentially be treated more favorably than salary for tax purposes. For example, NQOs may allow employers to deduct executive compensation above $1 million, and NQOs can generate tax deductions without a corresponding cash outlay. 8. [LO 2] What is a “disqualifying disposition” of ISOs, and how does it affect employees who have exercised ISOs? In order to receive the favorable tax treatment afforded incentive stock options, employees acquiring shares by exercising ISO’s must hold the shares for at least 2 years after the grant date and 1 year after the exercise date. Shares acquired with ISOs and sold prior to meeting these holding period requirements trigger a “disqualifying disposition.” Because disqualifying dispositions cause incentive stock options to be treated as nonqualified options for tax purposes, the bargain element is taxed at the time of sale at ordinary rates. 9. [LO 2] Compare and contrast how employers record book and tax expense for stock options. Under ASC 718, employers expense the economic value of option grants (determined on the grant date) ratably over the vesting period for book purposes for both incentive and nonqualified stock options. For tax purposes, employers expense the bargain element when nonqualified options are exercised by the employee. However, employers never receive a tax deduction for incentive stock options. 10. [LO 2] How is the tax treatment of restricted stock different from that of NQOs? How is it similar? Employees with nonqualified options are taxed at ordinary rates on the bargain element of the shares received on the date of exercise by the employee. In contrast, employees receiving restricted stock are taxed at ordinary rates on the fair market value of the shares on the date the restricted stock vests. The tax treatment of the two is similar in that both income elements are taxed at ordinary rates. 11. [LO 2] Matt just started work with Boom Zoom, Inc., a manufacturer of credit-card-sized devices for storing and playing back music. Due to the popularity of their devices, analysts expect Boom Zoom’s stock price to increase dramatically. In addition to his salary, Matt received Boom Zoom restricted stock. How will Matt’s restricted stock be treated for tax purposes? Should Matt consider making the section 83(b) election? What are the factors he should consider in making this decision? From a tax perspective, would this election help or hurt Boom Zoom? If Matt doesn’t make the 83(b) election, the fair market value of the stock on the vesting date will be included in Matt’s salary income in the year the stock vests and the restrictions lapse. Boom Zoom, Inc. will take a corresponding ordinary deduction in the same year Matt includes the value of the stock in his salary. If Matt makes an 83(b) election, he will include the fair market value of the stock on the grant date in his salary income in the year of grant and Boom Zoom will take a deduction of the same amount as compensation expense in the year of grant. Matt should consider making this election to accelerate income if the current stock price of Boom Zoom is small relative to his expectation of the future share price of Boom Zoom. Also, if Matt makes an 83(b) election and then leaves Boom Zoom prior to the restricted stock vesting, Matt will be precluded from claiming a loss on the basis he has in the stock that was forfeited. This inability to undo the 83(b) election in terms of acceleration income on an item that may eventually be forfeited should be considered. Under these conditions, the current tax Matt pays now will pale in comparison to the tax savings generated by converting the appreciation in share price from the grant date to the vesting date into capital gain. However, an 83(b) election under these conditions would be detrimental to Boom Zoom because its salary deduction, although accelerated, will be much smaller at the same before-tax cost. 12. [LO 2] What risks are assumed by employees making an 83(b) election on a restricted stock grant? If, after making an 83(b) election, the market value of the restricted shares stays flat (or declines), employees will have accelerated a tax payment without receiving the benefit of converting what would otherwise have been ordinary income into capital gain. Moreover, if the restricted stock subsequent to the 83(b) election is forfeited prior to the vesting date, employees will have reported income that they did not actually receive (phantom income). 13. [LO 3] Explain the differences and similarities between fringe benefits and salary as forms of compensation. A fringe benefit is a non-cash form of compensation. In contrast, salary is cash compensation. They are similar in that both fringe benefits and salary are forms of compensation provided to an employee by an employer. Salary and taxable fringe benefits are income to the employee and deductible by the employer. Nontaxable fringe benefits provide benefits to employees without tax consequences to the employee, but still allow an employer a tax deduction and reducing the after-tax cost of these benefits. 14. [LO 3] When an employer provides group-term life to an employee, what are the tax consequences to the employee? What are the tax consequences to the employer? The premiums paid for group-term life insurance coverage of up to $50,000 by an employer on behalf of an employee is excluded from an employee’s income. When an employee receives more than $50,000 of coverage, the taxpayer must recognize taxable income based on a formula determined by the regulations. A table requires a specified amount of income (which varies according to age) per $1,000 of life insurance coverage exceeding the threshold. The required income is likely to differ from the amount paid for the insurance by the employer. The cost of group-term life premiums is always deductible by the employer. 15. [LO 3] Compare and contrast the employer’s tax consequences of providing taxable versus nontaxable fringe benefits. From an employer perspective, both nontaxable and taxable fringe benefits are deductible as an ordinary and necessary compensation expense provided they are also reasonable in amount. The advantage of nontaxable fringe benefits to an employer is that employees may be willing to accept less cash compensation than it costs to provide the nontaxable fringe benefit. This lowers the actual cost of compensating employees, which is possible through an indirect government subsidy. Taxable fringe benefits are similar to salary and wages in that the amounts are includible in the employee’s income and deductible to the employer. 16. [LO 3] Mike is working his way through college and trying to make ends meet. Tara, a friend, is graduating soon and tells Mike about a really great job opportunity. She is the onsite manager for an apartment complex catering to students. The job entails working in the office for about 10 hours a week, collecting rent each month, and answering after-hours emergency calls. The owner of the apartment complex requires the manager to live onsite as a condition of employment. The pay is $10 per hour, plus a rent-free apartment (worth about $500 per month). Tara then tells him the best part: the rent-free apartment is tax-free as well. Knowing that you are a tax student, Mike asks you if the rent-free apartment is really tax-free or if Tara is mistaken. Explain to Mike whether the compensation for the apartment is really a nontaxable fringe benefit. The value of an apartment or lodging to an employee may be excluded from taxable income if the benefit is provided for the convenience of the employer and is required as a condition of employment. Since Mike is required to live on the premises in order to be an “onsite” manager, and he does so to provide services to the other tenants, he may exclude the value of the apartment from his income as a nontaxable fringe benefit under §132. 17. [LO 3] Assume that your friend has accepted a position working as an accountant for a large automaker. As a signing bonus, the employer provides the traditional cash incentive but also provides the employee with a vehicle not to exceed a retail price of $25,000. Explain to your friend whether the value of the vehicle is included, excluded, or partially included in the employee’s gross income. An employer can exclude a qualified employee discount from an employee’s taxable income because it is a nontaxable fringe benefit. A qualified employee discount is a discount not to exceed the cost of the good to the employer. As a result, the vehicle bonus should be partially taxable. The taxable portion would be the amount of the discount below the actual cost to manufacture the vehicle and will be included in gross income of the employee. The remaining value of the vehicle (fair market value less cost) can be received as a nontaxable fringe benefit. 18. [LO 3] Explain why an employee might accept a lower salary to receive a nontaxable fringe benefit. Why might an employee not accept a lower salary to receive a nontaxable fringe benefit? Employees prefer nontaxable benefits over an equivalent amount of salary or taxable benefits assuming that they need the benefits (e.g., health insurance) offered by the employer. This is because the government subsidizes the cost of qualified fringe benefits by allowing employees to receive them tax-free. Therefore, the after-tax costs of receiving lower salary and fringe benefits (non-qualified) are usually higher than receiving only salary and purchasing the needed benefits with after-tax dollars. An employee might be unwilling to accept a lower salary to receive a nontaxable benefit when the employee either doesn’t value the benefit or values the benefit less than the reduction in salary. 19. [LO 3] Describe a cafeteria plan and discuss why an employer would provide a cafeteria plan for its employees. A cafeteria plan is a set of fringe benefits an employer offers to employees while allowing employees to choose which benefits they prefer from the cafeteria “menu.” The simplest plans involve merely a choice between cash and a single nontaxable benefit, while others offer a large number of benefits. The benefits potentially available under a cafeteria plan are limited to cash and certain statutory benefits such as medical, disability and other accident or health plans, group-term life insurance, dependent care assistance, adoption assistance program, and §401(k) plan contributions. Employers provide cafeteria plans to employees because different employees may have different needs. With cafeteria plans, the employer provides employees with benefits of equal value but allow each employee to choose the specific benefits they desire. If the employee doesn’t want any of the fringe benefits, the employee can choose to take cash instead. This ensures that employees will receive equal value and does not benefit one class of employees over another. For example, if an employer simply offers health insurance, employees with dependents will receive more benefits than employees without dependents because of the increased health insurance costs of covering the dependents. Using a cafeteria plan, an employer can provide all employees with an amount equal to health insurance for a family. Employees with dependents can take the health insurance; single employees can choose the less expensive single health insurance and receive cash or another benefit with the difference. 20. [LO 3] Explain why Congress allows employees to receive certain fringe benefits tax-free but others are taxable? Congress allows employees to receive certain benefits (e.g. health insurance) tax-free as a subsidy to encourage employers to provide these benefits. Many of these benefits are considered to be in the public’s interest. For example, if employees have health insurance they are less likely to fall under Medicaid. In addition, employers are allowed a deduction. Together these incentives should decrease the after-tax cost of health insurance and result in increased coverage by employers. However, benefits that are considered luxuries (e.g., country club memberships) are generally taxed as compensation. If all fringe benefits were nontaxable, Congress would have to increase income tax rates or broaden the taxable base in order to generate additional income to pay for the subsidy. Further, employers and employees might get very creative in their compensation arrangements such that most of what employees receive would be in fringe benefit form. 21. [LO 3] Explain the policy reason for including the value of a country club membership provided to an executive as a taxable fringe benefit. Anytime Congress provides a nontaxable fringe benefit, they must either raise taxes, decrease spending, or increase debt. Since a country club membership creates little or no public benefit, it is likely unwise to raise taxes, cut other programs, or increase debt to provide a subsidy for executive perquisites or similar fringe benefits. Certain companies are famous for supplying benefits such as first-class dining facilities, gyms, laundry rooms, massage rooms, haircuts, carwashes, and dry cleaning however, the value of these benefits is taxable to its employees 22. [LO 3] Describe the circumstances in which an employee may not value a nontaxable fringe benefit. If a nontaxable benefit is either duplicated or unwanted, an employee generally will not place value on the benefit. For example, if a married taxpayer’s spouse is already a participant in an incredible health insurance package through his employer then the employee probably doesn’t value an additional incremental health insurance plan. If an employee lives within walking distance to work they probably would not take advantage of a qualified transportation fringe benefit (e.g., employer provided parking). In these cases, the employee would likely prefer a cafeteria plan that allows them to choose an alternative nontaxable fringe benefit or the ability to choose cash (taxable) instead. Problems 23. [LO 1] North Inc. is a calendar-year C corporation, accrual-basis taxpayer. At the end of the year 1, North accrued and deducted the following bonuses for certain employees for financial accounting purposes. • $7,500 for Lisa Tanaka, a 30 percent shareholder. • $10,000 for Jared Zabaski, a 35 percent shareholder. • $12,500 for Helen Talanian, a 20 percent shareholder. • $5,000 for Steve Nielson, a 0 percent shareholder. Unless stated otherwise, assume these shareholders are unrelated. How much of the accrued bonuses can North Inc. deduct in year 1 under the following alternative scenarios? a. North paid the bonuses to the employees on March 1 of year 2. b. North paid the bonuses to the employees on April 1 of year 2. c. North paid the bonuses to employees on March 1 of year 2 and Lisa and Jared are related to each other, so they are treated as owning each other’s stock in North. d. North paid the bonuses to employees on March 1 of year 2 and Lisa and Helen are related to each other, so they are treated as owning each other’s stock in North. a. North may deduct $35,000 in year 1 because the bonuses were paid within 2 ½ months of year end. Employee Deductible Year 1 Deductible Year 2 Lisa Tanaka $7,500 Jared Zabaski $10,000 Helen Talanian $12,500 Steve Nielson $5,000 $35,000 b. North may not deduct any of the bonus in year 1 because the bonuses were not paid within 2 ½ months of year end. It may deduct the $35,000 of bonuses in year 2. Employee Deductible Year 1 Deductible Year 2 Lisa Tanaka $7,500 Jared Zabaski $10,000 Helen Talanian $12,500 Steve Nielson $5,000 $35,000 c. North may deduct $17,500 in both year 1 and year 2. Helen and Steve’s bonuses are deductible in year 1 because they were paid within 2 ½ months of year end. Lisa and Jared’s bonuses are deductible in year 2 which is the year they take the bonuses into income—since they are related persons (own greater than 50 percent). Employee Deductible Year 1 Deductible Year 2 Lisa Tanaka $7,500 Jared Zabaski $10,000 Helen Talanian $12,500 Steve Nielson $5,000 $17,500 $17,500 d. North may deduct $35,000 in year 1. All of the shareholders’ bonuses are deductible in year 1 because they were paid within 2 ½ months of year end. Helen and Lisa are not considered to be related persons because together they own 50 percent but not more than 50 percent of North. Employee Deductible Year 1 Deductible Year 2 Lisa Tanaka $7,500 Jared Zabaski $10,000 Helen Talanian $12,500 Steve Nielson $5,000 $35,000 24. [LO1] {Research}Jorgensen High Tech Inc. is a calendar-year, accrual-method taxpayer. At the end of year 1, Jorgensen accrued and deducted the following bonuses for certain employees for financial accounting purposes. • $40,000 for Ken. • $30,000 for Jayne. • $20,000 for Jill. • $10,000 for Justin. How much of the accrued bonuses can Jorgensen deduct in year 1 under the following alternative scenarios? a. Jorgensen paid the bonuses to the employees on March 1 of year 2. b. Jorgensen paid the bonuses to the employees on April 1 of year 2. c. Jorgensen paid the bonuses to the employees on March 1 of year 2, and there is a requirement that the employee must remain employed with Jorgensen on the payment date to receive the bonus. d. Jorgensen paid the bonuses to employees on March 1 of year 2, and there is a requirement that the employee must remain employed with Jorgensen on the payment date to receive the bonus; if not, the forfeited bonus is reallocated to the other employees. a. Jorgensen may deduct $100,000 in year 1 because the bonuses were paid within 2 ½ months of year end. Employee Deductible Year 1 Deductible Year 2 Ken $40,000 Jayne $30,000 Jill $20,000 Justin $10,000 $100,000 b. None is deductible in year 1. Jorgensen may deduct $100,000 in year 2 because the bonuses weren’t paid within 2 ½ months of year end. Employee Deductible Year 1 Deductible Year 2 Ken $40,000 Jayne $30,000 Jill $20,000 Justin $10,000 $100,000 c. None is deductible in year 1. Jorgensen may deduct $100,000 in year 2 because the bonuses weren’t fixed at the end of year 1, see Reg. 1.461-1(a)(2)(i). The amounts were not considered fixed, because employees are eligible to receive the bonus only if they are employed on the date the bonuses were paid. This was the holding of the Tax Court in Bennett Paper Corp (1982) 78 TC 458. Employee Deductible Year 1 Deductible Year 2 Ken $40,000 Jayne $30,000 Jill $20,000 Justin $10,000 $100,000 d. Jorgensen may deduct $100,000 in year 1 because the bonuses were paid within 2 ½ months of year end and the amounts to be paid by Jorgensen were fixed—see Reg. 1.461-1(a)(2)(i). The amounts would be considered to be fixed at the end of the year, because if an employee leaves before the bonus is paid, the forfeited amount is reallocated to the other eligible employees. Thus the amount paid by Jorgensen is fixed—even if the specific recipient hasn’t been determined yet. 25. [LO 1] Lynette is the CEO of publicly traded TTT Corporation and earns a salary of $200,000 in the current year. What is TTT Corporation’s after-tax cost of paying Lynette’s salary excluding FICA taxes? TTT’s after-tax cost is $158,000, calculated as follows: Description Amount Explanation Before tax cost of salary: (1) Salary $200,000 (2) (1 – marginal tax rate) × 79% (1 – 21%) After tax cost of salary $158,000 (1) × (2) 26. [LO 1] Marcus is the CEO of publicly traded ABC Corporation and earns a salary of $1,500,000. What is ABC’s after-tax cost of paying Marcus’s salary? ABC’s after-tax cost is $1,290,000, calculated as follows: Description Amount Explanation Before tax cost of salary: (1) Salary $1,500,000 Taxes: (2) Deductible portion $1,000,000 Maximum deduction (3) Marginal tax rate × 21% (4) Tax deduction $210,000 (2) × (3) After tax cost of salary $1,290,000 (1) – (4) 27. [LO 2] {Tax Forms} Cammie received 100 NQOs (each option provides a right to purchase 10 shares of MNL stock for $10 per share). She started working for MNL Corporation four years ago (5/1/Y1) when MNL’s stock price was $8 per share. Now (8/15/Y5) that MNL’s stock price is $40 per share, she intends to exercise all of her options. After acquiring the 1,000 MNL shares with her stock options, she held the shares for over one year and sold (on 10/1/Y6) them at $60 per share. a. What are Cammie’s taxes due on the grant date (5/1/Y1), exercise date (8/15/Y5), and sale date (10/1/Y6), assuming her ordinary marginal rate is 32 percent and her long-term capital gains rate is 15 percent? b. What are MNL Corporation’s tax consequences on the grant date (5/1/Y1), exercise date (8/15/Y5), and sale date (10/1/Y6)? c. Complete Cammie’s Form 8949 and Schedule D for the year of sale. Also assume that the sale transaction of the MNL Corporation stock was not reported to Cammie on a Form 1099-B. a. Cammie recognizes no income on the grant date. Cammie recognizes $30,000 of ordinary income and pays tax of $9,600 in the year of exercise, calculated as follows: Description Amount Explanation (1) Shares acquired 1,000 (100 × 10 shares) (2) Exercise price $10.00 (3) Cash needed to exercise $10,000 (1) × (2) (4) Market price $40.00 (5) Market value of shares $40,000 (1) × (4) (6) Bargain Element (ordinary income) $30,000 (5) – (3) (7) Marginal Tax Rate 32% Tax due in year of exercise $9,600 (6) × (7) She also recognizes $20,000 of capital gain and pays tax of $3,000 in the year of sale, calculated as follows: Description Amount Explanation (8) Shares acquired with NQOs 1,000 (1) (9) Market price at sale $60.00 (10) Amount Realized $60,000 (8) x (9) (11) Basis $40,000 (5) (12) Long-term capital gain $20,000 (10) - (11) (13) Marginal Tax Rate 15% Tax due in year of exercise $3,000 (12) x (13) b. MNL has no tax consequences on the grant date or sale date. MNL does receive a deduction equal to the $30,000 (line (6) from part a) bargain element on the date Cammie exercises the options. This will reduce MNL’s tax burden by $6,300 ($30,000 × 21%). c. See forms below: 28. [LO 2] {Planning} Yost received 300 NQOs (each option gives Yost the right to purchase 10 shares of Cutter Corporation stock for $15 per share). At the time he started working for Cutter Corporation three years ago, Cutter’s stock price was $15 per share. Yost exercised all of his options when the share price was $26 per share. Two years after acquiring the shares, he sold them at $47 per share. a. What are Yost’s taxes due on the grant date, exercise date, and sale date, assuming his ordinary marginal rate is 35 percent and his long-term capital gains rate is 15 percent? b. What are Cutter Corporation’s tax consequences (amount of deduction and tax savings from deduction) on the grant date, the exercise date, and the date Yost sold the shares? c. Assume that Yost is “cash poor” and needs to engage in a same-day sale in order to buy his shares. Due to his belief that the stock price is going to increase significantly, he wants to maintain as many shares as possible. How many shares must he sell in order to cover his purchase price and taxes payable on the exercise? d. Assume that Yost’s options were exercisable at $20 and expired after five years. If the stock only reached $18 during its high point during the five-year period, what are Yost’s tax consequences on the grant date, the exercise date, and the date the shares are sold, assuming his ordinary marginal rate is 35 percent and his long-term capital gains rate is 15 percent? a. Yost has no tax consequences on the grant date. Yost recognizes $33,000 of ordinary income and pays tax of $11,550 in the year of exercise, calculated as follows: Description Amount Explanation (1) Shares acquired 3,000 (300 x 10 shares) (2) Exercise price $15.00 (3) Cash needed to exercise $45,000 (1) × (2) (4) Market price $26.00 (5) Market value of shares $78,000 (1) × (4) (6) Bargain Element (ordinary income) $33,000 (5) – (3) (7) Marginal Tax Rate 35% (8) Tax due in year of exercise $11,550 (6) x (7) He also recognizes $63,000 of capital gain and pays tax of $9,450 in the year of sale; the calculations are as follows: Description Amount Explanation (9) Shares acquired with NQOs 3,000 (1) (10) Market price at sale $47.00 (11) Amount Realized $141,000 (9) × (10) (12) Basis $78,000 (5) (13) Long-term capital gain $63,000 (11) - (12) (14) Capital Gain Tax Rate 15% Tax due in year of sale $9,450 (13) × (14) b. Cutter has no tax consequences on the grant date or sale date. Cutter does receive a deduction equal to the $33,000 (line (6) from part a) bargain element on the date Yost exercises the options. Cutter’s taxes are reduced by $6,930. (1) Bargain Element (ordinary income) $33,000 (6) from part a (2) Marginal Tax Rate 21% (3) Tax benefit in year of exercise $6,930 (1) × (2) c. Yost must sell 2,175 shares to pay the $56,550 ($45,000 to exercise plus $11,550 of tax) to complete the same day sale, the calculations are as follows: Description Amount Explanation (1) Cash needed to exercise $45,000 (3) from part a (2) Tax due at exercise $11,550 (8) from part a (3) Cash needed for same-day sale $56,550 (1) + (2) (4) Market price $26 (5) Shares needed to be sold 2,175 (3) / (4) d. Yost would not have exercised the options because the market price never exceeded the strike price. As a result, the options would expire unexercised and there will be no tax consequences for either Yost or Cutter. 29. [LO 2] Haven received 200 NQOs (each option gives him the right to purchase 20 shares of Barlow Corporation stock for $7 per share) at the time he started working for Barlow Corporation three years ago when its stock price was $7 per share. Now that Barlow’s share price is $50 per share, he intends to exercise all of his options. After acquiring the 4,000 Barlow shares with his stock options, he intends to hold the shares for more than one year and then sell the shares when the price reaches $75 per share. a. What are Haven’s taxes due on the grant date, exercise date, and sale date, assuming his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent? b. What are the cash flow effects for Barlow Corporation resulting from Haven’s option exercise? How would it change if Barlow’s marginal rate were 0 percent? a. Haven has no tax consequences on the grant date. Haven has an outflow of $28,000 on the exercise. Haven recognizes $172,000 of ordinary income and pays tax of $55,040 in the year of exercise, calculated as follows: Description Amount Explanation (1) Shares acquired 4,000 (200 x 20 shares) (2) Strike price $7.00 (3) Cash needed to exercise $28,000 (1) × (2) (4) Market price $50.00 (5) Market value of shares $200,000 (1) × (4) (6) Bargain Element (ordinary income) $172,000 (5) – (3) (7) Marginal Tax Rate 32% (8) Tax due in year of exercise $55,040 (6) × (7) He also recognizes $100,000 of capital gain and pays tax of $15,000 in the year of sale, the calculations are as follows: Description Amount Explanation (9) Shares acquired with NQOs 4,000 (1) (10) Market price at sale $75.00 (11) Amount Realized $300,000 (9) × (10) (12) Basis $200,000 (5) (13) Long-term capital gain $100,000 (11) - (12) (14) Capital Gain Tax Rate 15% Tax due in year of sale $15,000 (13) × (14) b. Barlow has no tax consequences on the grant date or sale date. Barlow does receive a deduction equal to the $172,000 (line (6) from part a) bargain element on the date Haven exercises the options and receive a tax benefit of $36,120. If Barlow had a tax rate of 0%, it would receive no tax savings from the deduction for the bargain element ($0 = ($172,000 x 0%)). (1) Bargain Element (ordinary income) $172,000 (6) from part a (2) Marginal Tax Rate 21% (3) Tax benefit in year of exercise $36,120 (1) × (2) 30. [LO 2] Mark received 10 ISOs (each option gives him the right to purchase 10 shares of Hendricks Corporation stock for $5 per share) at the time he started working for Hendricks Corporation five years ago, when Hendricks’s price was $5 per share. Now that Hendricks’s share price is $35 per share, Mark intends to exercise all options and hold all of his shares for more than year. Assume that more than a year after exercise, Mark sells the stock for $35 a share. a. What are Mark’s taxes due on the grant date, the exercise date, and the date he sells the shares assuming his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent? b. What are Hendricks’s tax consequences on the grant date, the exercise date, and the date Mark sells the shares? a. Mark has no tax consequences on the grant date. Mark has no regular income tax consequences on the exercise date, but recognizes $3,000 of income for AMT, calculated as follows: Description Amount Explanation (1) Shares acquired 100 (10 x 10 shares) (2) Exercise price $5.00 (3) Cash needed to exercise $500 (1) × (2) (4) Market price $35.00 (5) Market value of shares $3,500 (1) × (4) (6) Bargain Element (AMT preference)* $3,000 (5) – (3) *The bargain element is includable in AMTI, which may cause Mark to pay AMT. For AMT purposes, the basis of the acquired shares is $3,500 (the bargain element is added to the regular tax basis). In the year of sale, Mark recognizes $3,000 of long-term capital gain and pays tax of $450, calculated as follows: Description Amount Explanation (7) Shares acquired with ISOs 100 (1) (8) Market price at sale $35.00 (9) Amount Realized $3,500 (7) × (8) (10) Basis $500 (3) above (11) Long-term capital gain $3,000 (9) - (10) (12) Capital Gain Tax Rate 15% Tax due in year of sale $450 (11) × (12) In the year of the sale, for AMT purposes because the amount realized of $3,500 is equal to the AMT basis in the shares of $3,500 , there is no gain or loss on the sale of the stock for AMT. The difference between the regular taxable gain of $3,000 and the $0 reported AMT gain would be reported as a favorable AMT adjustment. b. Hendricks has no tax consequences on the grant date, exercise, or sale date because the options are ISOs. 31. [LO 2] Antonio received 40 ISOs (each option gives him the right to purchase 20 shares of Zorro stock for $3 per share) at the time he started working for Zorro Corporation six years ago. Zorro’s stock price was $3 per share at the time. Now that Zorro’s stock price is $50 per share, Antonio intends to exercise all of his options and immediately sell all the shares he receives from the options exercise. a. What are Antonio’s taxes due on the grant date, the exercise date, and the date the shares are sold assuming his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent? b. What are Zorro’s tax consequences on the grant date, the exercise date, and the date Antonio sells the shares? c. What are the cash flow effects of these transactions to Antonio assuming his ordinary marginal rate is 24 percent and his long-term capital gains rate is 15 percent? d. What are the cash flow effects to Zorro resulting from Antonio’s option exercise? a. Antonio has no tax consequences on the grant date. Since Antonio exercises and sells the shares immediately, he has a disqualifying disposition of ISOs, so they are treated like NQOs. Antonio recognizes $37,600 of ordinary income and pays $12,032 in taxes; the calculations are as follows: Description Amount Explanation (1) Shares acquired 800 (40 x 20 shares) (2) Exercise price $3.00 (3) Cash needed to exercise $2,400 (1) × (2) (4) Market price $50.00 (5) Amount Realized $40,000 (1) × (4) (6) Basis $2,400 (3) above (7) Bargain Element/Ordinary Income $37,600 (5) - (6) (8) Marginal Tax Rate 32% Tax paid in year of sale $12,032 (7) × (8) b. Because the options are treated like NQOs, Zorro has a deduction of $37,600 and tax savings of $7,896, calculated as follows: Description Amount Explanation (1) Bargain Element $37,600 from line 7 of part a (2) Ordinary Marginal Tax Rate 21% Tax benefit when shares vest $7,896 (1) × (2) c. Antonio has no cash flow consequences on the grant date. Since Antonio exercises and sells the shares immediately, he has a net cash inflow of $28,576. The disqualifying disposition of ISOs is treated like NQOs. Antonio recognized $40,000 (see line 5) in cash, pays $2,400 (see line 3) for the stock, and pays $9,024 (see last line) in taxes, calculated as follows: Description Amount Explanation (1) Shares acquired 800 (40 x 20 shares) (2) Exercise price $3.00 (3) Cash needed to exercise $2,400 (1) × (2) (4) Market price $50 (5) Amount Realized $40,000 (1) × (4) (6) Basis $2,400 (3) above (7) Bargain Element/Ordinary Income $37,600 (5) - (6) (8) Marginal Tax Rate 24% Tax paid in year of sale $9,024 (7) × (8) d. Zorro has positive cash flow of $10,296. Because the options are treated like NQOs, Zorro receives tax savings of $7,896 (from part b) plus $2,400 in cash from Antonio for the exercise of his options. 32. [LO 2] {Planning} Harmer Inc. is now a successful company. In the early days (before it became profitable), it issued ISOs to its employees. Now Harmer is trying to decide whether to issue NQOs or ISOs to its employees. Initially, Harmer would like to give each employee 20 options (each option allows employees to purchase one share of Harmer stock). For purposes of this problem, assume that the options are exercised in three years (three years from now) and that the underlying stock is sold in five years (five years from now). Assume that taxes are paid at the same time the income generating the tax is recognized. Also assume the following facts: • The after-tax discount rate for both Harmer, Inc. and its employees is 10 percent. • The corporate tax rate is 21 percent. • The personal (employee) ordinary income rate is 37 percent. • The personal (employee) long-term capital gains rate is 20 percent. • The exercise price of the options is $7. • The market price of Harmer at date of grant is $5. • The market price of Harmer at date of exercise is $25. • The market price of Harmer at date of sale is $35. Answer the following questions: a. Considering these facts, which type of option plan, NQO or ISO, should Harmer prefer? Explain. b. Assuming Harmer issues NQOs, what is Harmer’s tax benefit from the options for each employee in the year each employee exercises the NQOs? c. Assuming Harmer issues ISOs, what is the tax benefit to Harmer in the year the ISOs are exercised? d. Which type of option plan should Harmer’s employees prefer? e. What is the present value of each employee’s after-tax cash flows from year 1 through year 5 if the employees receive ISOs? f. What is the present value of each employee’s after-tax cash flows from year 1 through year 5 if the employees receive NQOs? g. How many NQOs would Harmer have to grant to keep its employees indifferent between NQOs and 20 ISOs? a. Harmer would prefer to issue NQOs. Profitable companies receive a tax benefit equal to the employee’s bargain element upon exercise. In contrast, Harmer receives no tax benefit if ISOs are used. b. Harmer’s per employee tax benefit upon exercise of the NQOs is $76, calculated as follows: Description Amount Explanation (1) Shares acquired 20 (20 x 1 shares) (2) Exercise price $7.00 (3) Cash needed to exercise $140 (1) × (2) (4) Market price $25.00 (5) Market value of shares $500 (1) × (4) (6) Bargain Element $360 (5) – (3) (7) Marginal Tax Rate 21% Tax benefit in year of exercise $76 (6) × (7) c. Harmer’s per employee tax benefit upon exercise of the ISOs is $0, because employers receive no deduction upon an ISO exercise. d. Harmer’s employees would prefer ISOs because the bargain element isn’t taxed upon exercise (creating tax deferral) and, if held for more than one year after exercise, the entire amount is taxed at preferential capital gains rates. e. The present value of ISOs to each employee is $260.01, calculated as follows: Description Amount Explanation (1) Shares acquired 20 (20 x 1 shares) (2) Exercise price $7.00 (3) Cash needed to exercise $140 (1) x (2) (4) Present Value Factor .751 10% discount rate for 3 years (5) Present Value of Cash to Exercise $105.14 (3) x (4) Description Amount Explanation (6) Shares acquired 20 (20 x 1 shares) (7) Market Price at Sale $35.00 (8) Amount Realized $700 (6) x (7) (9) Basis in Stock $140 (3) (10) Long-term capital gain $560 (8) - (9) (11) Capital Gains Tax Rate 20 % (12) Tax paid on capital gain in year of sale $112 (10) x (11) (13) Net cash inflow at sale $588 (8) - (12) (14) Present Value Factor .621 10% discount rate for 5 years (15) Present Value of Sale Proceeds $365.15 (13) x (14) (16) Present Value of ISOs $260.01 (15) - (5) f. The present value of NQOs to each employee is $204.84 calculated as follows: Description Amount Explanation (1) Shares acquired 20 (20 x 1 shares) (2) Exercise price $7.00 (3) Cash needed to exercise $140 (1) x (2) (4) Market price $25 (5) Market value of shares $500 (1) x (4) (6) Bargain Element $360 (5) – (3) (7) Marginal Tax Rate 37% (8) Tax paid on bargain element in year of exercise $133.20 (6) x (7) (9) Cash outflows at exercise date $273.20 (3)+(8) (10) Present Value Factor .751 10% discount rate for 3 years (11) Present Value of Cash to Exercise $205.17 (9) x (10) Description Amount Explanation (12) Shares acquired 20 (20 x 1 shares) (13) Market Price at Sale $35.00 (14) Amount Realized $700 (12) x (13) (15) Basis in stock $500 from (5) above (16) Long-term capital gain $200 (14) - (15) (17) Capital Gain Tax Rate 20 % (18) Tax paid on capital gain in year of sale $40 (16) x (17) (19) Net cash inflow at sale $660 (14) - (18) (20) Present Value Factor .621 10% discount rate for 5 years (21) Present Value of Sale Proceeds $409.86 (19) x (20) (22) Present Value of NQOs $204.69 (21) - (11) g. The number of NQOs necessary to make employees equal to receiving ISOs would be 26. This can be solved algebraically as follows by dividing the present value of ISOs by the present value of NQOs and multiplying the product by the number of ISOs received, calculated as follows: Description Amount Explanation (1) PV of ISOs $260.01 Part e, line 16 (2) PV of NQOs $204.69 Part f, line 22 (3) Ratio 1.270 (1) / (2) (4) ISOs received 20 (5) NQOs to break even with ISOs 25.40 (3) x (4) NQOs to be received 26 Line 5 rounded up to nearest whole option Alternatively, the solution can be obtained algebraically as follows: First, let’s find out how many additional NQOs Harmer would have to grant to their employees to keep them indifferent between receiving ISOs and NQO’s. We already determined above that the after-tax present value to each employee of receiving ISOs is $260.01. In essence, we have to give each employee enough additional NQOs so that on an after-tax basis the present value of receiving NQO’s is $260.01. By solving the following equation for the variable X, we can determine how many total NQOs each employee should be given to keep them indifferent across the two alternatives: What? You thought the algebra you learned back in high school would never be good for anything? Solving for X: X = 25.38 NQOs. We’ll assume Harmer does not want to issue fractional shares, so we’ll round up to 26 NQOs. So, Harmer will have to give each employee 8 more NQOs than ISOs to keep them indifferent. 33. [LO 2] On January 1, year 1, Dave received 1,000 shares of restricted stock from his employer, RRK Corporation. On that date, the stock price was $7 per share. Dave’s restricted shares will vest at the end of year 2. He intends to hold the shares until the end of year 4 when he intends to sell them to help fund the purchase of a new home. Dave predicts the share price of RRK will be $30 per share when his shares vest and will be $40 per share when he sells them. a. If Dave’s stock price predictions are correct, what are the taxes due on these transactions to Dave if his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent? b. If Dave’s stock price predictions are correct, what are the tax consequences of these transactions to RRK? a. Dave has no tax consequences on the grant date. On the vesting date he will recognize ordinary income of $30,000 and pay taxes of $9,600, which is calculated as follows: Description Amount Explanation (1) Shares acquired 1,000 (2) FMV at vesting date $30.00 (3) Ordinary income on vesting date $30,000 (1) x (2) (4) Ordinary Marginal Tax Rate 32% (5) Tax due when shares vest $9,600 (3) x (4) Dave will owe $1,500 on the sale date, which is calculated as follows: Description Amount Explanation (6) Amount realized $40,000 1,000 shares x $40 per share (7) Adjusted basis 30,000 From line 3 above. (8) Long-term capital gain $10,000 (6) – (7) (9) Capital Gain Tax Rate 15% Tax due when shares sold $1,500 (8) x (9) b. RRK will receive a tax benefit of $6,300 on the vesting date, which is calculated as follows: Description Amount Explanation (1) Shares acquired 1,000 (2) FMV at grant date $30.00 (3) Ordinary deduction on grant date $30,000 (1) x (2) (4) Ordinary Marginal Tax Rate 21% Tax benefit when shares granted $6,300 (3) x (4) RRK receives no benefit on the grant date or when Dave sells the shares. 34. [LO 2] On January 1, year 1, Dave received 1,000 shares of restricted stock from his employer, RRK Corporation. On that date, the stock price was $7 per share. On receiving the restricted stock, Dave made the 83(b) election. Dave’s restricted shares will vest at the end of year 2. He intends to hold the shares until the end of year 4 when he intends to sell them to help fund the purchase of a new home. Dave predicts the share price of RRK will be $30 per share when his shares vest and will be $40 per share when he sells them. Assume that Dave’s price predictions are correct and answer the following questions: a. What are Dave’s taxes due if his ordinary marginal rate is 32 percent and his long-term capital gains rate is 15 percent? b. What are the tax consequences of these transactions to RRK? a. Dave’s tax consequence on the grant date is that he will recognize $7,000 of ordinary income and pay taxes of $2,240, which is calculated as follows: Description Amount Explanation (1) Shares acquired 1,000 (2) FMV at grant date $7.00 (3) Ordinary income on grant date $7,000 (1) x (2) (4) Ordinary Marginal Tax Rate 32% (5) Tax due on grant date $2,240 (3) x (4) Dave will owe no tax on the vesting date since he made the 83(b) election. Dave will owe $4,950 on the sale, which is calculated as follows: Description Amount Explanation (6) Amount realized $40,000 1,000 shares x $40 per share (7) Adjusted basis 7,000 From line 3 above. (8) Long-term capital gain $33,000 (6) – (7) (9) Capital Gain Tax Rate 15% Tax due when shares sold $4,950 (8) x (9) b. RRK will receive a tax benefit of $1,470 on the grant date, which is calculated as follows: Description Amount Explanation (1) Shares acquired 1,000 (2) FMV at grant date $7.00 (3) Ordinary deduction on grant date $7,000 (1) x (2) (4) Ordinary Marginal Tax Rate 21% Tax benefit when shares granted $1,470 (3) x (4) RRK receives no benefit on the vesting date or when Dave sells the shares. 35. [LO 2] On January 1, year 1, Jessica received 10,000 shares of restricted stock from her employer, Rocket Corporation. On that date, the stock price was $10 per share. On receiving the restricted stock, Jessica made an 83(b) election. Jessica’s restricted shares will all vest at the end of year 4. After the shares vest, she intends to sell them immediately to fund an around-the-world cruise. Unfortunately, Jessica decided that she couldn’t wait four years and she quit her job to start her cruise on January 1, year 3. a. What are Jessica’s taxes due in year 1 assuming her marginal tax rate is 35 percent and her long-term capital gains rate is 15 percent? b. What are Jessica’s taxes due in year 3 assuming her marginal tax rate is 35 percent and her long-term capital gains rate is 15 percent? a. If Jessica makes the 83(b) election, she will owe $35,000 which is calculated as follows: Description Amount Explanation (1) Shares acquired 10,000 (2) FMV at section 83(b) election $10.00 (3) Ordinary income on election date $100,000 (1) x (2) (4) Ordinary Marginal Tax Rate 35% Tax due at election $35,000 (3) x (4) b. If Jessica leaves before the shares vest there are no tax consequences. She will recognize no loss and lose her compensatory basis in the restricted stock (the $35,000 recognized at the 83(b) election). 36. [LO 2] On May 1, year 1, Anna received 5,000 shares of restricted stock from her employer, Jarbal Corporation. On that date, the stock price was $5 per share. On receiving the restricted stock, Anna made an 83(b) election. Anna’s restricted shares will all vest on May 1, year 3. After the shares vest, she intends to sell them immediately to purchase a condo. True to her plan, Anna sold the shares immediately after they vested. a. What is Anna’s ordinary income in year 1? b. What is Anna’s gain or loss in year 3 if the stock is valued at $1 per share on the day the shares vest? c. What is Anna’s gain or loss in year 3 if the stock is valued at $9 per share on the day the shares vest? d. What is Anna’s gain or loss in year 3 if the stock is valued at $5 per share on the day the shares vest? a. If Anna makes the section 83(b) election, she will recognize $25,000 on the election date which is calculated as follows: Description Amount Explanation (1) Shares acquired 5,000 (2) FMV at section 83(b) election $5.00 Ordinary income on election date $25,000 (1) x (2) b. There are no tax consequences to Anna when the stock vests. When Anna sells her stock for $1 a share, she will recognize a long-term capital loss of $4 per share because her basis in each share is $5 ($20,000 loss in total). c. There are no tax consequences to Anna when the stock vests. When Anna sells the stock for $9 per share, she will recognize a long-term capital gain of $4 per share because her basis in each share is $5 ($20,000 gain in total). d. There are no tax consequences to Anna when the stock vests. When Anna sells the stock for $5 per share, she will not recognize any capital gain or loss because her basis in the stock is $5 per share. 37. [LO 2] {Planning} On January 1, year 1, Tyra works for Hatch Corporation. New employees must choose immediately between receiving seven NQOs (each NQO provides the right to purchase for $5 per share 10 shares of Hatch stock) or 50 restricted shares. Hatch’s stock price is $5 on Tyra’s start date. Either form of equity-based compensation will vest in two years. Tyra believes that the stock will be worth $15 per share in two years and $25 in four years when she will sell the stock. Tyra’s marginal tax rate is 32 percent and her long-term capital gains rate is 15 percent. Assuming that Tyra’s price predictions are correct, answer the following questions (ignore present value, use nominal dollars): a. What are the cash-flow effects to Tyra in the year she receives the options, in the year the options vest and she exercises the options, and in the year she sells the stock if she chooses the NQOs? b. What are the cash-flow effects to Tyra in the year she receives the restricted stock, in the year the stock vests, and in the year she sells the stock if Tyra chooses the restricted stock? c. What are the cash-flow effects to Tyra in the year she receives the restricted stock, in the year the stock vests, and in the year she sells the stock if she makes an 83(b) election? d. What recommendation would you give Tyra? Explain. a. Tyra’s net cash flow for the NQOs is $1,071, which calculated as follows: Description Amount Explanation (1) Amount Realized $1,750 Line 11 from table below (2) Cash outflow for shares at exercise ($350) Line 3 from table below (3) Cash outflow for taxes at exercise ($224) Line 8 from table below (4) Cash outflow for taxes at sale ($105) Line 15 from table below Net cash flow $1,071 (1)+(2)+(3)+(4) There is no cash flow on the grant date. The cash flow is negative $574 on the exercise date ($350 for the share purchase + $224 in taxes due at exercise). The cash flow on the sale date is $1,645 ($1,750 in sale proceeds less $105 in taxes due on the sale date). She must pay $350 for the shares on the exercise and pay $224 in taxes, the calculations are as follows: Description Amount Explanation (1) Shares acquired 70 (7 x 10 shares) (2) Exercise price $5.00 (3) Cash needed to exercise $350 (1) x (2) (4) Market price $15.00 (5) Market value of shares $1,050 (1) x (4) (6) Bargain Element (ordinary income) $700 (5) – (3) (7) Marginal Tax Rate 32% (8) Tax due in year of exercise $224 (6) x (7) She realizes $1,750 on the sale and pays $105 in taxes on the sale, the calculations are as follows: Description Amount Explanation (9) Shares acquired with NQOs 70 (1) (10) Market price at sale $25.00 (11) Amount Realized $1,750 (9) x (10) (12) Basis $1,050 (5) (13) Long-term capital gain $700 (11) - (12) (14) Capital Gain Tax Rate 15% (15) Tax due in year of sale $105 (13) x (14) b. Tyra’s net cash flow for the restricted stock is $935 ($1,175 from the year of sale less $240 from the year of exercise)., which is calculated as follows: Description Amount Explanation (1) Amount Realized $1,250 Line 6 from table below (2) Cash outflow for taxes at exercise ($240) Line 5 from table below (3) Cash outflow for taxes at sale ($75) Line 10 from table below Net cash flow $935 (1)+(2)+(3) There is no cash flow on the grant date. The cash flow is negative $240 on the vesting date for taxes due. The cash flow on the sale date is $1,175 ($1,250 in sale proceeds less $75 in taxes due on the sale date). Tyra will owe $240 of taxes on the vesting date. Description Amount Explanation (1) Shares acquired 50 (2) FMV at vesting date $15.00 (3) Ordinary income on vesting date $750 (1) x (2) (4) Ordinary Marginal Tax Rate 32% (5) Tax due when shares vest $240 (3) x (4) She realizes $1,250 on the sale and pays $75 in taxes on the sale, the calculations are as follows: Description Amount Explanation (6) Amount realized $1,250 50 shares x $25 per share (7) Adjusted basis 750 from line 3 above. (8) Long-term capital gain $500 (6) – (7) (9) Capital Gain Tax Rate 15% (10) Tax due when shares sold $75 (8) x (9) c. Tyra’s net cash flow for the restricted stock is $1,020, which calculated as follows: Description Amount Explanation (1) Amount Realized $1,250 Line 6 from table below (2) Cash outflow for taxes at election ($80) Line 5 from table below (3) Cash outflow for taxes at sale ($150) Line 10 from table below Net cash flow $1,020 (1)+(2)+(3) There is $80 negative cash flow on the grant date for taxes paid. There is no cash flow on the vesting date. The cash flow on the sale date is $1,100 ($1,250 in sale proceeds less $150 in taxes due on the sale date). Tyra will owe $80 of taxes on the grant date. Description Amount Explanation (1) Shares acquired 50 (2) FMV at election date $5.00 (3) Ordinary income on election date $250 (1) x (2) (4) Ordinary Marginal Tax Rate 32% (5) Tax due when election is made $80 (3) x (4) She realizes $1,250 on the sale and pays $150 in taxes on the sale, the calculations are as follows: Description Amount Explanation (6) Amount realized $1,250 50 shares x $25 per share (7) Adjusted basis 250 from line 3 above. (8) Long-term capital gain $1,000 (6) – (7) (9) Capital Gain Tax Rate 15% (10) Tax due when shares sold $150 (8) x (9) d. Tyra should elect the NQOs because it has the highest net cash flow of the three options. The additional shares that can be purchased through the NQOs is superior to the ability to lower the tax bill through the 83(b) election on the restricted stock. 38. [LO 3] Nicole’s employer, Poe Corporation, provides her with an automobile allowance of $20,000 every other year. Her marginal tax rate is 32 percent. Answer the following questions relating to this fringe benefit. a. What is Nicole’s after-tax benefit if she receives the allowance this year? b. What is Poe’s after-tax cost of providing the auto allowance? a. Nicole’s after tax benefit is $13,600, calculated as follows: Description Amount Explanation (1) Automobile allowance $20,000 Taxable fringe benefit (2) Marginal tax rate 32% (3) Income tax on allowance $6,400 (1) x (2) Total after-tax benefit $13,600 (1) - (3) b. Poe’s after tax cost is $15,800, calculated as follows: Description Amount Explanation (1) Automobile allowance $20,000 Taxable fringe benefit (2) Marginal tax rate 21% (3) Tax benefit of allowance $4,200 (1) x (2) Total after-tax cost $15,800 (1) - (3) 39. [LO 3] {Research} Bills Corporation runs a defense contracting business that requires security clearance. To prevent unauthorized access to its materials, Bills requires its security personnel to be on duty except for a 15-minute break every two hours. Since the nearest restaurants are a 25-minute round trip, Bills provides free lunches to its security personnel. Bills has never included the value of these meals in its employee’s compensation. Bills is currently under audit, and the IRS agent wants to deny Bills a deduction for past meals. The agent also wants Bills to begin including the value of the meals in employee compensation starting with the current year. As Bills’ tax advisor, provide a recommendation on whether to appeal the agent’s decision (Hint: see Boyd Gaming Corp., CA-9, 99-1 USTC ¶50,530 (Acq.), 177 F3d 1096). The primary question is whether the meals are “for the convenience of the employer.” In Boyd Gaming, the Ninth Circuit held that a casino providing a cafeteria on its premises for security and logistic reasons was allowed to exclude the meals as a de minimis fringe benefit because they were provided for the employer’s convenience. One important fact is that Boyd Gaming had a policy requiring employees to stay on the business premise during lunch breaks. The IRS subsequently acquiesced (will not challenge other taxpayers with similar fact patterns) in Announcement 99-77 (1999-32 CB 243). Bills Corporation should be able to rely on the Boyd Gaming decision; however, whether or not Bills requires employees to stay on its business premises is likely to be an important fact. 40. [LO 3] {Planning} Lars Osberg, a single taxpayer with a 35 percent marginal tax rate, desires health insurance. Volvo, his employer, has a 21 percent marginal tax rate. The health insurance would cost Lars $8,500 to purchase if he pays for it himself through the health exchange (Lars’s AGI is too high to receive any tax deduction for the insurance as a medical expense). Answer the following questions about this benefit. a. What is the maximum amount of before-tax salary Lars would give up to receive health insurance from Volvo? b. What would be the after-tax cost to Volvo to provide Lars with health insurance if it could purchase the insurance through its group plan for $5,000? c. Assume that Volvo could purchase the insurance for $5,000. Lars is interested in getting health insurance and he is willing to receive a lower salary in exchange for the health insurance. What is the least amount by which Volvo would be willing to reduce Lars’s salary while agreeing to pay his life insurance? d. Will Volvo and Lars be able to reach an agreement by which Volvo will provide Lars’s health insurance? a. Lars would be willing to trade at most $13,077 of before-tax salary to receive $8,500 [i.e., $8,500 / (1 – 35%)] of health insurance benefits. Lars should be indifferent between receiving $13,077 of compensation and $8,500 of nontaxable fringe benefits. b. The after-tax cost of providing Lars with the $5,000 of health insurance (a nontaxable fringe benefit) is $3,950 [$5,000 x (1 - .21)]. c. Volvo would reduce Lars’s salary by a minimum of $5,000 if it pays his health insurance. This is because whether the compensation is in the form of salary or fringe benefits, the amounts are deductible. d. Lars would be indifferent between reducing his before-tax salary by $13,077 or receiving the health insurance benefits. Lars would prefer to reduce his salary by less than $13,077 and still receive the benefits. Volvo, on the other hand, would be indifferent between reducing his salary by $5,000 or providing the health insurance (not both - the salary and the health insurance are tax deductible to Volvo, so the after-tax cost of these expenses for a given before-tax cost is equivalent). However, Volvo is better off if it reduces his salary by more than $5,000. Consequently, given that Volvo provides the insurance, any salary reduction of less than $13,077 makes Lars better off and any salary reduction greater than $5,000 makes Volvo better off. So, any salary reduction greater than $5,000 and less than $13,077 makes both parties better off. 41. [LO 3] {Tax Planning} Seiko’s current salary is $85,000. Her marginal tax rate is 32 percent and she fancies European sports cars. She purchases a new auto each year. Seiko is currently a manager for Idaho Office Supply. Her friend, knowing of her interest in sports cars, tells her about a manager position at the local BMW and Porsche dealer. The new position pays only $75,000 per year, but it allows employees to purchase one new car per year at a discount of $15,000. This discount qualifies as a nontaxable fringe benefit. In an effort to keep Seiko as an employee, Idaho Office Supply offers her a $10,000 raise. Answer the following questions about this analysis a. What is the annual after-tax cost to Idaho Office Supply if it provides Seiko with the $10,000 increase in salary? b. Financially, which offer is better for Seiko on an after-tax basis and by how much? (Assume that Seiko is going to purchase the new car whether she switches jobs or not.) c. What salary would Seiko need to receive from Idaho Office Supply to make her financially indifferent (after taxes) between receiving additional salary from Idaho Office Supply and accepting a position at the auto dealership? a. The after-tax cost of providing Seiko with $10,000 of additional salary is $7,900. This is calculated as follows: Description Amount Explanation (1) Additional salary $10,000 (2) Marginal tax rate 21% (3) Income tax benefit $2,100 (1) × (2) After-tax cost of additional salary $7,900 (1) - (3) b. The after-tax value to the employee of Idaho Business Supply’s package is $64,600, calculated as follows: So the after-tax value of the potential employer is better ($66,000) than Idaho Business Supply ($64,600). c. The current employer would have to offer her $97,059 ($95,000 + $2,059) , because the after-tax difference between the two offers is $1,400 ($66,000 versus $64,600). Therefore, if Seiko’s current employer provided her with $2,059 of additional salary [$1,400/(1-.32)] she would be indifferent. 42. [LO 1, 3] JDD Corporation provides the following benefits to its employee, Ahmed (age 47): The life insurance is a group-term life insurance policy that provides $200,000 of coverage for Ahmed. Assuming Ahmed is subject to a marginal tax rate of 32 percent, what is his after-tax benefit of receiving each of these benefits? The after-tax benefit of Ahmed’s salary and benefits is $360,414, calculated as follows: Description Amount Explanation Taxable Benefits (1) Salary $300,000 (2) Personal use of company jet $200,000 (3) Life Insurance (taxable portion) $270 ($150,000 × (.15 cents per $1,000) x 12 (4) Taxable Total $500,270 (1) + (2) + (3) (5) Marginal tax rate 32% (6) Income tax on benefits $160,086 (4) x (5) (7) After-tax benefit of taxable items $340,184 (4) – (6) Nontaxable Benefits (8) Health Insurance $10,000 (9) Dental Insurance $2,000 (10) Life Insurance (nontaxable portion) $2,730 $3,000 – (3) (11) Dependent Care $5,000 (12) Professional Dues $500 (13) Nontaxable Total $20,230 (8) + (9) + (10) + (11) + (12) After-tax benefit of salary and benefits $360,414 (7) + (13) 43. [LO3] Gray’s employer is now offering group-term life insurance. The company will provide each employee with $100,000 of group-term life insurance. It costs Gray’s employer $300 to provide this amount of insurance to Gray each year. Assuming that Gray is 52 years old, determine the monthly premium that Gray must include in income as a result of receiving the group-term life insurance benefit. Because Gray is 52, the amount included into income is 23 cents per $1,000 of coverage. The monthly premium that must be included in income is as follows: (1) Amount of Life Insurance $100,000 (2) Tax free benefit limit ($50,000) Statutory limit (3) Taxable Benefit $50,000 (1)+(2) (4) Divide by 1,000 50 (5) Cost Per $1,000 0.23 Exhibit 12-8 Monthly Premium $11.50 (4) x (5) 44. [LO3] Brady graduated from SUNY-New Paltz with his bachelor’s degree recently. He works for Makarov & Company CPAs. The firm pays his tuition ($10,000 per year) for him so that he can receive his Master of Science in Taxation which will qualify him to sit for the CPA exam. How much of the $10,000 tuition benefit does Brady need to include in income? Section 127(a)(2) allows individuals to exclude up to $5,250 of tuition benefits from income annually. Brady’s taxable amount is calculated as follows: (1) Tuition benefit $10,000 (2) Excludable amount ($5,250) Statutory limit Taxable amount $4,750 (1)+(2) 45. [LO3] Meg works for Freedom Airlines in the accounts payable department. Meg and all other employees receive free flight benefits (for the employee, family, and 10 free buddy passes for friends per year) as part of their employee benefits package. If Meg uses 30 flights with a value of $12,350 this year, how much must she include in her compensation this year? The flight benefits qualify as a no additional cost service and may be completely excluded from gross income under §132(a)(1). The Treasury Regulations (§1.132-2) specifically exclude airline benefits from gross income. 46. [LO3] {Tax Research} Sharmilla works for Shasta Lumber, a local lumber supplier. The company annually provides each employee with a Shasta Lumber shirt so that employees look branded and advertise for the business while wearing the shirts. Are Shasta’s employees required to include the value of the shirts in income? §132(a)(4) excludes de minimis fringe benefits from taxable income. However, §132(e) defines fringe benefits “any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable.” The Treasury regulations under §132 (§1.132-1) give specific examples which suggest that a shirt with a company logo may be excluded from gross income. However, the authority doesn’t explicitly mention the benefit received by Sharmilla. As a practical matter, most employers provide similar types of benefits and exclude the amount from employees’ income. 47. [LO3] {Tax Research} LaMont works for a company in downtown Chicago. The company encourages employees to use public transportation (to save the environment) by providing them with transit passes at a cost of $275 per month. a. If LaMont receives one pass (worth $275) each month, how much of this benefit must he include in his taxable income each year? b. If the company provides each employee with $275 per month in parking benefits, how much of the parking benefit must LaMont include in his taxable income each year? a) Under §132(f)(5)(A), an employer may exclude transit passes as a qualified transportation fringe benefits. The amounts described in the Code are not indexed, but the IRS annually provides the indexed amounts in a Revenue Procedure. For 2020, the amount is $270 for qualified transportation fringe as described in Rev. Proc. 2018-57. LaMont must include $60 of the benefit into taxable income $5 ($275 of benefits less $270 exclusion) per month into income). b) Under §132(f)(5)(C), an employer may exclude qualified parking as a qualified transportation fringe benefits. The amounts described in the Code are not indexed, but the IRS annually provides the indexed amounts in a Revenue Procedure. For 2020, the amount is $+270 for qualified parking as described in Rev. Proc. 2018-57. LaMont must include $60 of the benefit into taxable income $5 ($275 of benefits less $270 exclusion) per month into income). 48. [LO 3] Jarvie loves to bike. In fact, he has always turned down better paying jobs to work in bicycle shops where he gets an employee discount. At Jarvie’s current shop, Bad Dog Cycles, each employee is allowed to purchase four bicycles a year at a discount. Bad Dog has an average gross profit percentage on bicycles of 25 percent. During the current year, Jarvie bought the following bikes: Description Retail Price Cost Employee Price Specialized road bike $3,200 $2,000 $2,240 Rocky Mountain mountain bike $3,800 $3,200 $3,040 Trek road bike $2,700 $2,000 $1,890 Yeti mountain bike $3,500 $2,500 $2,800 a. What amount is Jarvie required to include in taxable income from these purchases? b. What amount of deductions is Bad Dog allowed to claim from these transactions? a) Under §132(a)(2), an employer may exclude from an employee’s income discounts that do not exceed the employer’s cost of goods it provides in the ordinary course of its business. Therefore, Jarvie must include $295 into taxable income: Description Retail price less average gross profit percentage Employee Price Income Specialized road bike $2,400 $2,240 $160 Rocky Mountain mountain bike $2,850 $3,040 $0 Trek road bike $2,025 $1,890 $135 Yeti mountain bike $2,625 $2,800 $0 Income $295 b) Bad Dog is not allowed a deduction for the employee discounts it provides its employees. It may include the $9,700 ($2,000 + $3,200 + $2,000 +$2,500) for the cost of the goods sold to employees in its cost of goods sold. 49. [LO 1, 3] Matt works for Fresh Corporation. Fresh offers a cafeteria plan that allows each employee to receive $15,000 worth of benefits each year. The menu of benefits is as follows: Benefit Cost Health insurance--single $5,000 Health insurance--with spouse $8,000 Health insurance--with spouse and dependents $11,000 Dental and vision $1,500 Dependent care--any specified amount up to $5,000 Variable Adoption benefits--any specified amount up to $5,000 Variable Educational benefits--any specified amount (no limit) Variable 401(k)--any specified amount up to $10,000 Variable Cash-- any specified amount up to $15,000 plan benefit Variable For each of the following independent circumstances, determine the amount of income Matt must recognize and the amount of deduction Fresh may claim: a. Matt selects the single health insurance benefit and places $10,000 in his 401(k). b. Matt selects the single health insurance benefit, is reimbursed $5,000 for MBA tuition, and takes the remainder in cash. c. Matt selects the single health insurance benefit and is reimbursed for MBA tuition of $10,000. d. Matt gets married and selects the health insurance with his spouse benefit and takes the rest in cash to help pay for the wedding. e. Matt elects to take all cash. a. Matt must recognize $0, because each of the benefits is a nontaxable fringe benefit. Fresh receives a deduction of $15,000 for the benefits paid. b. Matt must recognize $5,000, because he receives cash and two nontaxable fringe benefits. Educational assistance benefits have a maximum nontaxable amount of $5,250. Fresh receives a deduction of $15,000 for the benefits paid. c. Matt must recognize $4,750 of taxable income because his MBA tuition exceeded the maximum nontaxable amount of $5,250. Fresh receives a deduction of $15,000 for the benefits paid. d. Matt must recognize $7,000 of taxable income for the cash received. The $8,000 of health insurance is a nontaxable fringe benefit. Fresh receives a deduction of $15,000 for the benefits paid. e. Matt must recognize $15,000 of taxable income for the cash received. Fresh receives a deduction of $15,000 for the benefits paid. Comprehensive Problems 50. [LO 1, 2] {Planning}{Tax Forms} Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation packages from which Pratt may choose. Pratt will start working for Ferndale on January 1, year 1. Benefit Description Option 1 Option 2 Option 3 Option 4 Salary $60,000 $50,000 $45,000 $45,000 Health Insurance No coverage $5,000 $5,000 $5,000 Restricted stock $0 $0 1,000 shares $0 NQO’s $0 $0 $0 100 options Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1) shares are expected to be worth $10 per share on the vesting date at the end of year 1; and no 83(b) election is made. Assume that the NQOs (100 options) each allow the employee to purchase 10 shares at $5 exercise price. The stock trades at $5 per share on the grant date (January 1, year 1) and is expected to be worth $10 per share on the vesting date at the end of year 1, and the options are exercised and sold at the end of the year. Also assume that Pratt spends on average $3,000 on health-related costs that will be covered by insurance if he had coverage or is an after-tax expense if he isn’t covered by insurance (treat this as a cash outflow). Assume that Pratt’s marginal tax rate is 35 percent. (Ignore FICA taxes and time value of money considerations). a. What is the after-tax value of each compensation package for year 1? b. If Pratt’s sole consideration is maximizing after-tax value for year 1, which scheme should he select? c. Assuming Pratt chooses Option 3 and sells the stock on the vesting date (on the last day of year 1), complete Pratt’s Schedule D and Form 8949 for the sale of the restricted stock. a. The solution assumes that no 83(b) election is made for Option 3. Pratt’s after-tax value for each of the options is $36,000, $32,500, $35,750, and $27,500 respectively, calculated as follows: Option 1 Description Amount Explanation (1) Salary $60,000 (2) Restricted Stock $0 (3) Taxable Total $60,000 (1) + (2) (4) Tax Rate 35% (5) Tax Paid $21,000 (3) × (4) (6) After-tax cash value $39,000 (3) – (5) (7) NQO’s $0 (8) Health care expenses $3,000 After-tax value $36,000 (6) + (7) – (8) Option 2 Description Amount Explanation (1) Salary $50,000 (2) Restricted Stock $0 (3) Taxable Total $50,000 (1) + (2) (4) Tax Rate 35% (5) Tax Paid $17,500 (3) × (4) (6) After-tax cash value $32,500 (3) – (5) (7) NQO’s $0 (8) Health care expenses $0 After-tax value $32,500 (6) + (7) – (8) Option 3 Description Amount Explanation (1) Salary $45,000 (2) Restricted Stock $ 10,000 1,000 shares x $10/share (3) Taxable Total $55,000 (1) + (2) (4) Tax Rate 35% (5) Tax Paid $19,250 (3) x (4) (6) After-tax cash value $35,750 (3) – (5) (7) NQO’s $0 (8) Health care expenses $0 After-tax value $35,750 (6) + (7) – (8) Option 4 Description Amount Explanation (1) Salary $45,000 (2) NQO’s $5,000 Bargain element – 1,000 shares * ($10 – $5) (3) Taxable Total $50,000 (1) + (2) (4) Tax Rate 35% (5) Tax Paid $17,500 (3) x (4) (6) Net cash received at exercise $5,000 $5 ($10 sale less $5 exercise price) x 1,000 shares (7) After-tax cash value $27,500 (1) – (5) + (6) (8) Health care expenses $0 After-tax value $32,500 (7) - (8) b. Pratt should select Option 1 ($36,000) because it maximizes his after-tax value. c. See forms below: The restricted stock is included as income by Pratt on Line 7 of Page 1 of the 1040. Pratt’s inclusion of income creates basis, so that the gain or loss on the same day sale of the stock is $0 ($10,000 proceeds less the $10,000 basis). 51. Santini’s new contract for 2020 indicates the following compensation and benefits: Benefit Description Amount Salary $130,000 Health insurance $9,000 Restricted stock granted $2,500 Bonus $5,000 Hawaii trip $4,000 Group-term life insurance $1,600 Parking ($300 per month) $3,600 Santini is 54 years old at the end of 2020. He is single and has no dependents. Assume that the employer matches $1 for $1 for the first $6,000 that the employee contributes to his 401(k) during the year. The restricted stock grant is 500 shares granted when the market price was $5 per share. Assume that the stock vests on December 31, 2020, and that the market price on that date is $7.50 per share. Also assume that Santini is willing to make any elections to reduce equity-based compensation taxes. The Hawaii trip was given to him as the outstanding sales person for 2019. The group-term life policy gives him $150,000 of coverage. Assume that Santini does not itemize deductions for the year. Determine Santini’s taxable income and income tax liability for 2020. Santini’s taxable income is $129,736, and his income tax liability is $25,216, each is calculated as follows: Description Amount Explanation Taxable Benefits (1) Salary $130,000 $130,000 (given) (2) Restricted stock grant $2,500 500 shares x $5 on grant date with an §83(b) election (3) Bonus $5,000 Given (4) Hawaii trip $4,000 Given (5) Life Insurance (taxable portion) $276 $100,000= (.23 cents per $1,000) x 12 months (6) Parking $360 $30 per month ($300 per month - $270 (statutory limit)) × 12 months (7) AGI $142,136 Sum of items (1) through (6) (8) Standard Deduction $12,400 2020 single standard deduction (9) Taxable Income $129,736 (7) – (8) Income Tax Liability $25,216 [((9) -$85,525) × 24%] + $14,605.5 52. [LO 1, 3] {Planning} Sylvana is given a job offer with two alternative compensation packages to choose from. The first package offers her $250,000 annual salary with no qualified fringe benefits. The second package offers $235,000 annual salary plus health and life insurance benefits. If Sylvana were required to purchase the health and life insurance benefits herself, she would need to pay $10,000 annually after taxes. Assume her marginal tax rate is 35 percent. a. Which compensation package should she choose and by how much would she benefit in after-tax dollars by choosing this package? b. Assume the second package offers $230,000 plus the benefits instead of $235,000 plus benefits. Which compensation package should she choose and by how much would she benefit in after-tax dollars by choosing this package? a. Sylvana is better off by $250 by choosing Option 2. Option 1 ($152,500) has a lower after-tax value than Option 2 ($152,750). Option 1 Option 2 Salary $250,000 $235,000 (1-.35) (1-.35) ATCF from salary $162,500 $152,750 Cost of benefits ($10,000) $0 After tax dollars $152,500 $152,750 b. Sylvana is better off by $3,000 by choosing Option 1. Option 1 ($152,500) now has a higher after-tax value than Option 2 ($149,500). So Sylvana would be better off taking Option 1. Option 1 Option 2 Salary $250,000 $230,000 (1-.35) (1-.35) `ATCF from salary $162,500 $149,500 Cost of benefits ($10,000) $0 After tax dollars $152,500 $149,500 53. {Planning} In the current year, Jill, age 35, received a job offer with two alternative compensation packages to choose from. The first package offers her $90,000 annual salary with no qualified fringe benefits, requires her to pay $3,500 a year for parking, and to purchase life insurance at a cost of $1,000. The second package offers an $80,000 annual salary, employer provided health insurance, annual free parking (worth $320 per month), $200,000 of life insurance (purchasing on her own would have been $1,000 annually), and free flight benefits (she estimates that it will save her $5,000 per year). If Jill chooses the first package, she will purchase the health and life insurance benefits herself at a cost of $1,000 annually after taxes and spend another $5,000 in flights while traveling. Assume her marginal tax rate is 32 percent. a. Which compensation package should she choose and by how much would she benefit in after-tax dollars by choosing this compensation package instead of the alternative package? b. Assume the first package offers $100,000 salary instead of $90,000 salary plus benefits and the other benefits and costs are the same. Which compensation package should she choose and by how much would she benefit in after-tax dollars by choosing this package? a. Jill is better off by $3,259 by choosing Option 2. Option 2 ($54,959) has a higher after-tax value than Option 1 ($50,700). So Jill would be better off taking Option 2. Option 1 Option 2 Salary $90,000 80,000 Includible health insurance 0 0 Includible life insurance 0 $162 Includible parking 0 $660 Includible flight benefits 0 0 (1-0.32) (1-0.32) ATCF from salary $61,200 $54,959 Cost of parking ($3,500) 0 Cost of life insurance $(1,000) 0 Cost of flights ($5,000) 0 After tax dollars $51,700 $54,959 b. Jill is better off by $5,541 by choosing Option 1. Option 1 ($58,500) has a higher after-tax value than Option 2 ($54,959). So Jill would be better off taking Option 1. Option 1 Option 2 Salary $100,000 80,000 Includible health insurance 0 0 Includible life insurance 0 $162 Includible parking 0 $660 Includible flight benefits 0 0 (1-0.32) (1-0.32) ATCF from salary $68,000 $54,959 Cost of parking ($3,500) 0 Cost of life insurance $(1,000) 0 Cost of flights ($5,000) 0 After tax dollars $58,500 $54,959 Solution Manual for McGraw-Hill's Taxation of Individuals and Business Entities 2021 Brian C. Spilker, Benjamin C. Ayers, John A. Barrick, Troy Lewis, John Robinson, Connie Weaver, Ronald G. Worsham 9781260247138, 9781260432534
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