LeapFrog 2011 Annual Report Download - page 122

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.
Restricted Stock Awards
Generally, the recipient of a restricted stock award will recognize ordinary compensation income at the
time the stock is received equal to the excess, if any, of the fair market value of the stock received over any
amount paid by the recipient in exchange for the stock. If, however, the stock is not vested when it is received
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