LeapFrog 2006 Annual Report Download - page 121

Incentive stock options granted under the Equity Plan are intended to qualify for favorable tax treatment
under Section 422 of the Code. There generally are no federal income tax consequences to the optionee or us by
reason of the grant or exercise of an incentive stock option. However, the exercise of an incentive stock option
may increase the optionee’s alternative minimum tax liability, if any. If an optionee holds stock acquired through
exercise of an incentive stock option for more than two years from the option grant date and more than one year
from the date on which the shares are transferred to the optionee upon exercise of the option, any gain or loss on
a disposition of such stock will be a long-term capital gain or loss. Generally, if the optionee disposes of the
stock before the expiration of either of these holding periods (a “disqualifying disposition”), then at the time of
disposition the optionee will realize taxable ordinary income equal to the lesser of (i) the excess of the stock’s
fair market value on the exercise date over the exercise price, or (ii) the optionee’s actual gain, if any, on the
purchase and sale. The optionee’s additional gain or any loss upon the disqualifying disposition will be a capital
gain or loss, which will be long-term or short-term depending on whether the stock was held for more than one
year. To the extent the optionee recognizes ordinary income by reason of a disqualifying disposition, we
generally will be entitled (subject to the requirement of reasonableness, the provisions of Section 162(m) of the
Code and the satisfaction of a tax reporting obligation) to a corresponding business expense deduction in the tax
year in which the disqualifying disposition occurs.
Stock Bonus and Restricted Stock Awards. There are no tax consequences to the recipient or us by reason
of the grant of a stock bonus or restricted stock award. Upon receipt of the stock pursuant to such award, the
recipient normally will recognize taxable ordinary income equal to the excess of the stock’s fair market value
over the purchase price, if any. However, to the extent the stock is subject to certain types of vesting restrictions,
the taxable event will be delayed until the restrictions lapse, unless the recipient elects to be taxed on receipt of
the stock by filing a Section 83(b) election. With respect to employees, we generally are required to withhold an
amount based on the ordinary income recognized. Generally, we will be entitled (subject to the requirement of
reasonableness, the provisions of Section 162(m) of the Code and the satisfaction of a tax reporting obligation) to
a business expense deduction equal to the taxable ordinary income realized by the recipient. Upon disposition of
the stock, the recipient will recognize a capital gain or loss equal to the difference between the selling price and
the sum of the amount paid for such stock plus any amount recognized as ordinary income upon acquisition (or
vesting) of the stock. Such gain or loss will be long-term or short-term depending on whether the stock was held
for more than one year. Certain different rules may apply to recipients who are subject to Section 16(b) of the
Exchange Act.
Restricted Stock Unit Awards. No taxable income is recognized upon receipt of a restricted stock unit
award. The recipient generally will recognize ordinary income in the year in which the shares subject to that unit
are actually vested and issued to the recipient in an amount equal to the fair market value of the shares on the
date of issuance. The recipient and LeapFrog will be required to satisfy certain tax withholding requirements
applicable to such income. Generally, we will be entitled (subject to the requirement of reasonableness, the
provisions of Section 162(m) of the Code and the satisfaction of a tax reporting obligation) to an income tax
deduction equal to the amount of ordinary income recognized by the recipient at the time the shares are issued. In
general, the deduction will be allowed for the taxable year in which such ordinary income is recognized by the
recipient.
Stock Appreciation Rights.No taxable income is realized upon the receipt of a stock appreciation right.
Upon exercise of the stock appreciation right, the fair market value of the shares (or cash in lieu of shares)
received is recognized as ordinary income to the recipient in the year of such exercise. Generally, with respect to
employees, we are required to withhold from the payment made on exercise of the stock appreciation right or
from regular wages or supplemental wage payments an amount based on the ordinary income recognized.
Generally, LeapFrog will be entitled (subject to the requirement of reasonableness, the provisions of
Section 162(m) of the Code, and the satisfaction of a tax reporting obligation) to an income tax deduction in the
year in which such ordinary income is recognized by the recipient.
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