Five years ago in March, Kelley Incorporated issued 1,000 shares of its publicly traded stock as compensation to its employee, Thomas. On the date of issuance, the stock’s fair market value was $20,000. Under the terms of his employment contract, Thomas could not dispose of the stock or terminate his employment with Kelley before March of the current year. Otherwise, he had to forfeit the stock back to Kelley. Thomas did not make an election to recognize income in the year of receipt. The restrictions lapsed in March of the current year when Thomas was still a Kelley employee and the value of the stock was $35,000. In December of the current year, Thomas sold all 1,000 shares for the current fair market value of $50,000. How much capital gain or capital loss must Thomas recognize in the current year?

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Begin by outlining the scenario: Kelley granted Thomas 1,000 shares as compensation five years ago, with a $20,000 fair market value at issuance. Restrictions prevented sale or termination, and Thomas did not elect to recognize income in the year of receipt. The restrictions lapsed in March of the current year, when the stock’s value was $35,000, and Thomas remained an employee. In December, he sold all shares for $50,000.

Option A: "$20,000 capital loss." This is incorrect because the $20,000 figure reflects the stock’s FMV at the time of issuance, not any taxable gain or loss later. Since the taxation occurs when restrictions lapse (or upon sale, depending on election), the $20,000 amount isn’t treated as a loss upon sale.

Option B: "No capital gain or loss." This is inaccurate because a sale occurred with a proceeds amount ($50,000) different from the basis established after vesting. Once the stock becomes taxable and the basis is set, selling for a different amount will produce a gain or loss.

Option C: "$15,000 capital gain." This is the correct outcome under the restricted stock rules. Because Thomas did not elect to recognize income in the year of receipt, ordinary income is recognized when the restrictions lapse. The lapse value is $35,000, which becomes Thomas’s ordinary income and his basis for the stock. When he sells for $50,000, the gain is $50,000 minus $35,000, equal to $15,000. The holding period from March to December is under a year, so this is a short-term capital gain.

Option D: "$35,000 capital gain." This option would imply the entire lapse value is a capital gain, which is not correct here because the lapse value is taxed as ordinary income, not as a capital gain. The basis is adjusted to reflect the ordinary income; the actual capital gain is determined by the sale price minus that adjusted basis ($50,000 − $35,000 = $15,000).

In summary, the crucial steps are: (1) determine that no election means taxation occurs at vesting; (2) use the lapse value ($35,000) as both ordinary income and the stock’s basis; (3) compute the sale gain as $50,000 minus $35,000, yielding $15,000 short-term capital gain.

SP25-BL-BUS-A327-1377 Exam 1 Practice

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