Probate & Trust Law Section Conference Manual ... - Minnesota CLE

Summary of Option Strategies
5. to descendants for
cash
6. to descendants for
note
Holder sells options to
descendants in exchange for cash;
can be used for vested options
and perhaps unvested options as
well
Same as 5, except buyers deliver
note instead of cash
Removes ordinary income taint
from options at discounted value;
also transfers growth in value of
options (or resulting stock) value
to next generation in a manner
that reduces potential estate tax
burden if options were to be
retained until death
Same as 5, but net wealth transfer
is limited to growth beyond
interest charged on note
Sale triggers immediate ordinary
tax to seller equal to sale price
(which must equal FMV of
options at transfer – i.e., option
spread plus time value, less any
applicable discounts); company
receives deduction equal to
seller’s ordinary income at sale;
subsequent exercise of options by
buyers is tax-free; at sale of stock,
buyers subject to capital gains tax
on excess of stock value over
amount paid to seller
Same as 5, except for argument
that installment method of
accounting may apply, thus
deferring ordinary tax on sale
until seller receives principal
payments on note; if installment
method applies, then ordinary tax
will apply to untaxed gain
embedded in note as note
principal is collected or cancelled
at or after death of seller (in
addition to any estate tax
exposure on value of note at
death)
No gift taxes imposed on sale,
provided consideration equals
FMV of options at sale; growth in
value of options (or resulting
stock) beyond amount paid to
seller received by buyers free of
future gift or estate tax;
consideration received by seller
will be taxed in seller’s estate
Same as 5; but note must have
FMV, not just face amount, that
equals FMV of options –
common belief is that note paying
applicable federal rate, with
reasonable security and term, has
FMV equal to face amount
Option plan must allow sales for
consideration; control over option
exercise and resulting stock shifts
to donees; if purchase price is
questioned, then transaction may
be treated as partial gift and
partial sale; buyers must have
cash to pay purchase price at
outset; valuation of options and
associated discounts subject to
IRS challenge; IRS ruling on
unvested options technically not
applicable to sales, so sales of
unvested options are feasible (and
rewarding because of additional
discount to recognize possibility
of non-vesting), but somewhat
risky tax-wise; if stock does not
perform, buyers forfeit security
(which may exceed value of
options purchased)
Same as 5, except that buyers’
cash need at closing alleviated by
note; principal can be deferred
until maturity, but bona fide loan
must be created – requires
adequate security, adequate
interest (equal to applicable
federal rate (AFR)) must be paid
at least annually, note FMV must
equal FMV of options; value of
note and options and associated
discounts subject to IRS
challenge; buyers must have cash
flow to meet annual interest
obligations and to repay principal
at maturity; reliance on
installment method is extremely
risky, since there is adverse
precedent but virtually no
supporting authority
CONFIDENTIAL
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