Section 174 R&E Deduction Upon Statutory Stock Option Exercise

Posted: 29 Dec 2005

See all articles by J. Anthony Coughlan

J. Anthony Coughlan

PricewaterhouseCoopers Ltd. of Hong Kong

Abstract

Employee stock options, in large measure, have fueled the high-technology boom of recent years. Cash-strapped high-tech startup firms make up for the low salaries they offer with grants of stock options. Such firms face a choice: They can award nonstatutory stock options, or they can award statutory options. There are pros and cons to each type of option. Upon exercise, nonstatutory stock options are taxable to the employee and may be deducted by the employer under section 162. In contrast, statutory options upon exercise are not taxable to the employee and may not be deducted by the employer under section 162. These pros and cons of each type of option may balance each other out, and which type of option to award may therefore be of little importance for many profitable companies.

Yet for many high-tech startup companies, not having a section 162 deduction upon the exercise of a statutory option is not so bad: Because they are startups, they very well might not realize a profit anyway. If they do not realize a profit, then they do not have taxable income. And if they do not have taxable income, then they do not need an additional deduction. That is, because the company might never be able to utilize the good tax attributes of a nonstatutory stock option (the deduction), there does not seem to be much reason to saddle their employees with the bad tax consequences (taxable income upon exercise of the option). For this reason, the startup firm often would prefer to grant statutory options.

Suggested Citation

Coughlan, J. Anthony, Section 174 R&E Deduction Upon Statutory Stock Option Exercise. Tax Lawyer, Vol. 58, No. 2, Winter 2005, Available at SSRN: https://ssrn.com/abstract=872561

J. Anthony Coughlan (Contact Author)

PricewaterhouseCoopers Ltd. of Hong Kong ( email )

21/F, Edinburgh Tower
15 Queen's Road Central
Hong Kong
Hong Kong

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