457(f) and mutual fund options

[Guest EAKarno]

Speaking strictly of legitimate options with fixed exercise prices --It seems to me that if the Service were to impose any tax at grant (or upon subsequent vesting) on any thing beyond the intrinsic value, then there ought not to be a subsequent tax upon exercise. Taxing the value of the option privilege, in addition to taxing the spread, seems like taxation of the full economic value of the option to me. To tax it again upon exercise would truly be double taxation rather than just taxation done in two phases.

As for options with floating exercise prices, I anticipate that they will eventually be taxed simply as deferred compensation (for both taxable and tax exempts) without any grandfathering whatsoever.

[Guest kkost]

EAKarno: I understand what you are saying but the concept is that the value of the vested option granted is the amount of the deferred compensation which must be recognized in the year that it becomes vested under 457(f). Later, when there is an actual transfer of property in exchange for services (upon exercise), the value of the property received less the amount of income previously recognized under 457(f) is the ordinary income recognized under §83 in the year of transfer. In the year that the property is transferred, you get a full credit for the amount of income previously recognized so there is no double taxation. This is the same result that would occur if the promise was to make a future payment of money instead of stock or units - amounts would be taxed when deferred if vested. When amounts are later made available, they are taxed to the extent that the full amount was not previously recognized by the participant. As a result, there is no "double" tax - it is just that there are two recognition events to accelerate recognition of a portion of the whole compensatory amount.

[Guest kkost]

Sorry - I should have said offset rather than "credit" in the prior post.

[Alf]

Can someone help me with two questions about the proposed regulations?

1) What is taxed at vesting for discounted options? The spread only or does value have to be given to the option element under bs?

2) Do the regulations apply to employee deferrals only or employer money only?

[Guest kkost]

Both employee and employer deferrals are taxed when vested.

Regarding valuation, in response to a question like yours, the comments from the draftsman at the ABA Tax meeting in May indicated that the spread is not a valid measure of value and that something along the lines of BS is (in their minds) a more appropriate measure of the true value.