LeapFrog 2010 Annual Report Download - page 127

the federal, state, local, and other tax consequences of the grant or exercise of an award or the disposition of
stock acquired as a result of an award. The 2011 EIP is not qualified under the provisions of Section 401(a) of the
Tax Code, and is not subject to any of the provisions of the Employee Retirement Income Security Act of 1974.
Our ability to realize the benefit of any tax deductions described below depends on our generation of taxable
income as well as the requirement of reasonableness, the provisions of Section 162(m) of the Tax Code and the
satisfaction of our tax reporting obligations.
Incentive Stock Options
The 2011 EIP provides for the grant of stock options that qualify as “incentive stock options,” as defined in
Section 422 of the Tax Code. Under the Tax Code, an optionee generally is not subject to ordinary income tax
upon the grant or exercise of an incentive stock option. If the optionee holds a share received on the exercise of
an incentive stock option for more than two years from the date the option was granted and more than one year
from the date the option was exercised, which is referred to as the required holding period, the difference, if any,
between the amount realized on a sale or other taxable disposition of that share and the holder’s tax basis in that
share will be long-term capital gain or loss.
If, however, an optionee disposes of a share acquired on exercise of an incentive stock option before the end
of the required holding period, which is referred to as a disqualifying disposition, the optionee generally will
recognize ordinary income in the year of the disqualifying disposition equal to the excess, if any, of the fair
market value of the share on the date the incentive stock option was exercised over the exercise price. However,
if the sales proceeds are less than the fair market value of the share on the date of exercise of the option, the
amount of ordinary income recognized by the optionee will not exceed the gain, if any, realized on the sale. If the
amount realized on a disqualifying disposition exceeds the fair market value of the share on the date of exercise
of the option, that excess will be short-term or long-term capital gain, depending on whether the holding period
for the share exceeds one year.
For purposes of the alternative minimum tax, the amount by which the fair market value of a share of stock
acquired on exercise of an incentive stock option exceeds the exercise price of that option generally will be an
adjustment included in the optionee’s alternative minimum taxable income for the year in which the option is
exercised. If, however, there is a disqualifying disposition of the share in the year in which the option is
exercised, there will be no adjustment for alternative minimum tax purposes with respect to that share. In
computing alternative minimum taxable income, the tax basis of a share acquired on exercise of an incentive
stock option is increased by the amount of the adjustment taken into account with respect to that share for
alternative minimum tax purposes in the year the option is exercised.
We are not allowed an income tax deduction with respect to the grant or exercise of an incentive stock
option or the disposition of a share acquired on exercise of an incentive stock option after the required holding
period. If there is a disqualifying disposition of a share, however, we are allowed a deduction in an amount equal
to the ordinary income includible in income by the optionee.
Nonstatutory Stock Options
Generally, there is no taxation upon the grant of a nonstatutory stock option if the option is granted with an
exercise price equal to the fair market value of the underlying stock on the grant date. On exercise, an optionee
will recognize ordinary income equal to the excess, if any, of the fair market value on the date of exercise of the
stock over the exercise price. If the optionee is employed by us or one of our affiliates, that income will be
subject to withholding tax. Generally, the optionee’s tax basis in those shares will be equal to their fair market
value on the date of exercise of the option, and the optionee’s capital gain holding period for those shares will
begin on that date. We will generally be entitled to a tax deduction equal to the taxable ordinary income realized
by the optionee.
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