Tax deduction of options is a benefit that some companies may enjoy.

It comes about because gains on options are taxable and they're paid by the option holder.

So if a company has given an employee some options, then it's the employee's duty to pay that tax.

However, in some cases where the options are structured as non-qualified, the company can deduct the gain.

The option holder enjoys against taxable income.

So basically the tax authorities have said we're going to receive some tax from the employee.

We will give that back as a benefit to the company so the tax authorities end up in a neutral position.

The company will get the tax benefit, though only when the options are exercised.

So let's have a look at an example.

In the top box here, we've got the individual.

The individual has 10 options with a strike price of 12 and a share price of 14.

They're thus in the money.

The gain on exercise enjoyed by the individual is 14 minus 12, which is two.

That's the gain per option times by 10 options giving us a total gain of 20.

That employee thus has to pay tax on that at 30%, and they have to pay tax of six.

Now let's go to the company's perspective.

The cost of buying out the options from the employee is 20.

They have to hand the gain to the employee, but because of that tax that's paid by the employee, there's a tax shield generated that the company can use against taxable income.

Thus, the cost of 20 is slightly offset by the six, and the net cost of buying out the options is 14.

Now the options have to be structured correctly for this to be the case.

In an acquisition situation, this would be found out during the tax due diligence.

But as we can see from the cost of 20 reducing down to 14, if a company was looking to acquire a target and there were lots of options that had to be purchased, this tax shield generated could make a significant reduction in the acquisition price.