>>> sawicky at epinet.org 10/10/00 11:28AM >>>
Now when is the premium between the exercise price of the option and the current price of the stock taxable? Are you taxed on the spread when you exercise the option, and is your basis for the stock then the price of the stock on the day you exercised the option? Or is your basis the exercise price of the option, and are you taxed on the whole bundle when you sell the stock? I think the first, but all of a sudden I'm not sure. I used to know this... Brad DeLong
I never knew it, till now. According to my J.K. Lasser, the short answer is the option is not taxed when received or exercised, only when the stock is sold. So on this count the transfer of income does imply a revenue drain since capital gains rates are much lower than rates on ordinary income or corporate income. One exception is if the holding period is short -- then the 'ordinary' income rates apply. A second is that the spread is subject to the AMT (which also has lower marginal rates). The basis is the price gross of the spread -- the purchase price of the stock. But it can get much more complicated, naturally.
So on the whole the transfer is indeed tax bounty for the rich.
CB: The rationale for this being that the rich will invest their riches , and that's the engine of the economy. Laffer curve, supply-side. And see the New Economy ? It works !