ES$-19.$ Suppose you are employed by MS Corporation. In year $1.$ you received nonqualified employee stock options $($ NQO s $)$ to acquire $10,000$ shares of MS ss stock at an exercise price of $$40$ share. On that date, the stock traded at $$35$ per share. In year $2,$ yoe exercised your options when the stock price was $$48$ per share. In year $3,$ you sold the stock for $$50$ per share.

a$.$ What is the amount and character $($ordinary or capital gain$)$ of your income in years $1,2$ and $3$ because of these transactions?

b$.$ How much is MS$\text{'}$s tax deduction and when is it deductible?

c$.$ How much will MS report as compensation expense each period?

d$.$ How would your answers to questions $($a$),($b$),$ and $($c$)$ change if the options were incentive stock options?

$($Adapted from exercise written by Richand Sansing, Dartmouth College.$)$