Unlike traditional incentive stock options, non-qualified stock options (also known as non-quals or NQSOs) are transferable.

Because they are often highly leveraged investments, non-qualified stock options are often used to transfer wealth between generations. Their leverage allows investors to transfer more wealth between generations without incurring estate or gift taxes.

If the options can be exercised only for restricted stock, they have to be valued after first applying a discount to the underlying stock.

Revenue Procedure 98-34 and 2002-45
IRS Rev. Proc. 98-34 and Rev. Proc. 2002-13, as modified by 2002-45, provide a safe-harbor method for valuing stock options. (Rev. Proc. 2002-13 provides a slightly modified version of the valuation method provided in Rev. Proc. 98-34). Rev. Proc. 98-34 requires that:

• Either the Black-Scholes -Merton or binomial method be used
• In many cases, the maximum remaining term be used (in other cases, a term based on FAS 123R disclosures is permitted)
• The stock-return volatility specified in the company's annual report be used
• No discounts be applied to the result, although discounts still apply to the underlying stock if it is illiquid

This safe-harbor procedure does not always produce fair market value, as that term is typically defined in the Internal Revenue Code. Significantly lower values may be appropriate for assets included on tax returns. Because Pluris has access to empirical data on warrant transactions from the LiquiStat™ database, we are in a unique position to determine and defend discounts for illiquid options and warrants.

For more information on our valuations of non-qualified stock options, contact Pluris today.