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D or Dot.bomb? The Unpleasant Tax Surprise of Stock Options in a Volatile Market By Shelley Rhoades-Catanach, Villanova University Abstract This case explores the tax treatment of employee stock options and tax and financial planning issues associated with stock option exercise. The number of employee stock option plans and related option grants has increased dramatically in the last decade. Today, employees from top management down to rank-and-file workers often own substantial numbers of options and shares of employer stock acquired through option exercise. While these holdings can be valuable forms of compensation, option exercise can also be costly and risky. Following the stock market boom early in 2000 and its substantial decline later that same year, many employees that exercised options during the growth period were left with large tax bills. In some cases, the taxes owed exceeded the value of the optioned stock at year-end. This case details the tax and financial impact of option exercise on one employee that choose to hold on to optioned stock during the stock market crash of 2000. The educational objectives of the case include (1) familiarizing students with the tax and financial aspects of compensatory stock options, (2) identifying the risks and rewards of option grant and exercise, (3) quantifying the cash inflows and outflows associated with stock options and their tax consequences, and (4) planning to maximize the after-tax value of compensation received in the form of stock options. Introduction Corporate employers often seeks ways to link employee compensation to firm performance. Compensation granted in the form of employer stock or options to acquire employer stock provide a popular alternative. A stock option is the right to purchase a stated number of shares of the employer’s stock for a stated price (option or strike price) for a stated period of time. Typically, the strike price is equal to or less than the market pri