Hi, Can anybody tell me how a company receive tax benefit from stock options? I don’t catch this idea. (Book 3- reading 41 - page 571).
Tax Benefits from Stock Options Many companies grant stock options to senior management to align their interests with those of shareholders. When options are exercised and converted into common stock, the company is allowed to take a deduction on its tax return equal to the difference between the price that shares were issued to senior management at (the strike or exercise price) and the current market price. Let’s work with an example to illustrate how this works. Suppose the market price of a company’s stock is $70 and the exercise price of options on its stock is $50. When employees exercise their options, the company effectively loses $20 per share because it is selling shares to employees at only $50 when they are valued by the market at $70. This loss lowers the company’s earnings before tax, but the company does benefit from a tax shield (similar to an interest or depreciation tax shield) as it is able to recognize greater expenses on its income statement and reduce taxes payable. Some companies classify this tax reduction as a cash inflow from operating activities on the cash flow statement, while others categorize it as an inflow from financing activities.
Thank you for responding my question. So the tax deduction could be recognized in BOTH income statement and tax return, right? (because you said a bit differently in your explanation and the example)
Yes its on both the tax return and the income statement. Its just like an interest tax shield. Higher interest and option-related expense results in lower before tax income so there is a tax benefit.