Assume that on January 1, year 1, XYZ Corp. issued 1,000 non-qualified stock options with an estimated value of $4 per option. Each option entitles the owner to purchase one share of XYZ stock for $14 a share (the per share price of XYZ stock on January 1, year 1, when the options were granted). The options vest 25 percent a year (on December 31) for four years (beginning with year 1). All 500 stock options that had vested to that point were exercised in year 3 when the XYZ stock was valued at $20 per share. No other options were exercised in year 3 or year 4. Identify XYZ’s year 1, 2, 3, and 4 tax deductions and book-tax difference (identify as permanent and/or temporary) associated with the stock options under the following alternative scenarios: 1. ASC 718 does not apply to the stock options.
2. ASC 718 applies to the stock options.