CEP Investment Strategies 2 — Questions and Answers
Question 1: An employee holds ISOs and is considering exercising them. Which of the following is a key tax planning consideration specific to ISOs?
- ISO gains are always taxed as ordinary income in the exercise year
- The spread at exercise may trigger the Alternative Minimum Tax (AMT) (Correct answer)
- ISO exercises must be reported on Form W-2 regardless of sale date
- ISO options lose their preferential tax treatment if held more than 5 years
Correct answer: The spread at exercise may trigger the Alternative Minimum Tax (AMT)
ISO exercises can trigger AMT because the bargain element (spread) is an AMT preference item, even though it is not recognized as regular income at exercise.
Question 2: Which strategy allows an employee to exercise stock options and immediately sell enough shares to cover the total exercise cost and taxes?
- Same-day sale (cashless exercise) (Correct answer)
- Net exercise (share withholding)
- Section 83(b) election
- Stock swap exercise
Correct answer: Same-day sale (cashless exercise)
A same-day sale, or cashless exercise, allows the employee to exercise and simultaneously sell shares, using the proceeds to cover exercise costs and taxes without needing upfront cash.
Question 3: What is the primary risk of concentrating a large portion of one's investment portfolio in employer stock?
- Dividend income may be taxed at higher rates
- Lack of diversification increases exposure to company-specific risk (Correct answer)
- Options vesting schedules become more complex
- Employer stock is excluded from ERISA protections
Correct answer: Lack of diversification increases exposure to company-specific risk
Holding concentrated employer stock subjects an employee to both human capital risk (job loss) and financial capital risk from the same source, violating basic diversification principles.
Question 4: Under a '10b5-1 plan,' what protection does a corporate insider gain?
- Exemption from short-swing profit rules under Section 16(b)
- An affirmative defense against insider trading claims when trades are pre-scheduled (Correct answer)
- The ability to trade during any blackout period
- Accelerated vesting of unvested equity awards
Correct answer: An affirmative defense against insider trading claims when trades are pre-scheduled
A Rule 10b5-1 plan allows insiders to pre-schedule trades when they are not aware of material non-public information, providing an affirmative defense against insider trading allegations.
Question 5: A participant receives RSUs and wants to minimize tax liability at vesting. Which strategy could defer taxation if permitted by the plan?
- Electing Section 83(b) treatment at grant date
- Enrolling in a non-qualified deferred compensation (NQDC) arrangement (Correct answer)
- Requesting a stock swap at vesting
- Exercising a same-day sale immediately upon vesting
Correct answer: Enrolling in a non-qualified deferred compensation (NQDC) arrangement
If the equity plan permits, deferring RSU settlement into a NQDC plan can postpone ordinary income recognition until the elected distribution date.
Question 6: Which of the following best describes a 'protective put' strategy for an employee holding vested company shares?
- Selling covered calls to generate premium income on held shares
- Buying put options on employer stock to limit downside while maintaining upside (Correct answer)
- Exchanging shares for a fixed annuity contract
- Donating shares to a charitable remainder trust
Correct answer: Buying put options on employer stock to limit downside while maintaining upside
A protective put involves purchasing put options on shares already held, setting a floor on losses while allowing participation in further price appreciation.
Question 7: When evaluating whether to hold or sell shares acquired through an ESPP, which factor most directly determines whether the sale qualifies as a qualifying disposition?
- Whether the shares were purchased at a discount greater than 5%
- The holding period relative to the offering date and grant date (Correct answer)
- The number of shares sold relative to total holdings
- Whether the plan is Section 423-qualified
Correct answer: The holding period relative to the offering date and grant date
A qualifying ESPP disposition requires holding shares for more than two years from the offering date AND more than one year from the purchase date; violating either threshold results in a disqualifying disposition.
CEP Investment Strategies 2
An employee holds ISOs and is considering exercising them.
Which of the following is a key tax planning consideration specific to ISOs?