SECTION 5. EXAMPLES

.01 Example 1 . An employee holds an option for 100 shares of Company A stock at an exercise price of $20 per share. When granted, the option had no readily ascertainable fair market value. The employee exercises the option on January 15, 2003, receives substantially vested shares and immediately sells the shares for the fair market value of $30 per share. The sale is executed by a broker rendering its services to Company A employees through a contractual arrangement with Company A. The broker charges no commissions or other fees to the employee in connection with the sale of the shares. Company A uses the sale price of the shares to calculate the compensation income of the employee reported as wages on Form W–2.

Under these facts, the employee has compensation income of $10 per share under § 83(a) ($30 fair market value minus $20 exercise price). Company A certifies in writing to the broker that it will report $1,000 as wages of the employee, and includes that amount on the employee’s Form W–2. The employee’s basis is $30 per share ($20 cost of exercising the option plus $10 taxable income recognized). Because the employee’s amount realized on the sale of the stock ($30 per share) equals his basis, the employee has no capital gain or loss on the sale. The broker is not required to report the proceeds of the sale on Form 1099–B.

.02 Example 2 . Assume the same facts as Example 1, except that the employee pays a commission of $.05 per share to the broker. The employee’s compensation income is $10 per share ($30 fair market value of stock received minus $20 exercise price). Company A reports $1,000 as wages on the employee’s Form W–2 (as in Example 1 ), since commission expense does not reduce the income generated by the exercise. The employee has a loss of $5.00 ($.05 per share times 100 shares). Because the employee realizes a loss, “excepted sale” treatment will apply only if the broker provides the statement required by section 4.03 to the employee.