Income Tax Consequences of Exercised Options

From: "Roberta Kleinman" <roberta_kleinman@hotmail.com>
Subject: Income Tax Consequences of Exercised Options
Date: Tue, 02 Feb 1999 15:23:01 CST

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My sister just informed me that this past December she and her husband 
decided to exercise some company stock options her husband had been 
given a few years ago by his employer.  They had not been able to 
exercise the options earlier because of minimum time restrictions 
imposed by the company on how long the options had to be held before 
they could be exercised.  The exercise price of the options ($38) was 
only about one fourth the market price of the stock on the date of 
exercise, which market price was then at or near its all time high.  
They did not immediately turn around and sell the shares they acquired 
by exercising the options because they thought if they held the shares 
for at least a year and then sold them they would qualify for long term 
capital gain treatment on any profits.  The market value of the shares 
has decreased somewhat since the date of exercise. 

Now my sister is concerned because she has reviewed the relevant 1998 
income tax publications and believes that she and her husband will be 
required to pay about $9000 in 1998 income taxes on the difference 
between the exercise price of the options and the (sky high) market 
value of the stock on the date of exercise, despite the fact that the 
stock has not actually been sold, they have not realized any positive 
cash flow from the sale, and the stock now has a lower market price than 
on the date of exercise.  Is she correct?  If so, are they at least 
entitled to the lower long term gains rate because they held the options 
for longer than one year?  Is there any way they could have handled this 
matter differently which would have allowed them to defer realization of 
"profits" from the option exercise until the acquired stock was sold, 
thus avoiding a big tax bill this April?  At this point, would it be 
possible to sell an equivalent amount of stock borrowed from their 
broker in order to raise immediate funds to pay the tax due?  And would 
this course of action have the desired effect of entitling them to the 
long term capital gains rate for profits resulting from the eventual 
liquidation of the current shares of stock?

Any informed advice would be greatly appreciated.
               

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