Note that the holder may be taxed even if the stock received on option exercise is held, and not sold. However, as discussed below, if the stock received on exercise is subject to a substantial risk of forfeiture, and is not transferable, there is no immediate tax. Jones elects to hold the stock instead of selling it. The corporation that issues to Jones the stock is required to withhold income tax, social security tax, and Medicare tax based on this income. Because the corporation is not paying to Jones cash from which it can withhold the tax, it will require Jones to write a check to the corporation to cover the withholding requirement.
Exercise occurs when the holder pays the exercise price and receives the stock.
A more complicated strategy for deferring tax, as compared to the use of nonqualified options, is the use of restricted stock. If either or both of these conditions are present the stock is taxable. Therefore, tax can be deferred by issuing stock that is both nontransferable, and subject to a substantial risk of forfeiture. When either of these conditions lapses, the holder of the stock is taxed based on the value of the stock at the time of the lapse. However, assume the stock is nontransferable, and that it is subject to a substantial risk of forfeiture.