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By Michael Gray

AMT Relief Bills Introduced

As I mentioned in the last Option Alert, legislation was simultaneously introduced in the House of Representatives and the Senate on August 2, 2001 to provide relief to employees who exercised incentive stock options during 2000. Under the proposal, taxpayers who had an alternative minimum tax for 2000 from the exercise of an incentive stock option would be able to recompute the additional income for AMT reporting. The income would be limited to the excess of the fair market value of the stock on April 15, 2001 (or the sales price, if sold before that date) over the option price.

The House Bill is H.R. 2794 and the Senate Bill is S. 1324.

Senator Lieberman, who introduced the legislating in the Senate, described 2000 as “The Perfect Storm” for employees who exercised incentive stock options. He also acknowledged that offsetting revenue increase legislation would be required to pass the proposed legislation, which would reduce government tax revenues by about $1.3 billion over ten years.

Payroll Tax Reform Proposed For ISOs and ESPPs

Legislation clarifying the treatment of ordinary income from the early disposition of incentive stock options and employment tax from employee stock purchase plans, such as social security and medicare withholding, has been simultaneously introduced in the House of Representatives and the Senate.

Under the proposal, ordinary compensation income relating to ISOs and ESPPs would be exempt from employment taxes. Employers also would not be required to withhold income taxes for that income.

Representative Houghton introduced H.R. 2695 in the House of Representative on August 1, 2001. Senator Clinton introduced S. 1383 in the Senate on August 3, 2001.

The Internal Revenue Service has temporarily suspended enforcing employment taxes and income tax withholding for ordinary income from ISOs and ESPPs.

California Franchise Tax Board Discusses Change of
Residence and Employee Stock Options

The California Franchise Tax Board published an article about income tax reporting for incentive stock options and non-qualified stock options in the July/August 2001 issue of its newsletter, Tax News.

Here is a summary of some of the items discussed.

When an employee was a California resident when granted non-qualified stock options then moves and exercises the option when the employee is a non-resident of California, the income is characterized as compensation for services with a source in the state where the taxpayer performed the services. A suggested way to determine the part of the compensation with a California source and taxable in California is to compute a ratio. The ratio is California workdays from the date of grant to the date of exercise divided by the total workdays from the date of grant to the date of exercise.

When an employee was a California resident when granted an incentive stock option then moves and makes a disqualifying disposition when the employee is a non-resident of California, the ordinary compensation income is allocated to California using the same ratio as for a non-qualified option. Any capital gain is allocated to the state of residence.

If the employee is no longer working for the employer who granted the options when he or she moves, and all of the services were performed in California, all of the income will be allocated to California.

(Note – California handles ISOs differently from the state of New York. In Michaelson v. The New York State Tax Commission (New York Court of Appeals, July 8, 1986, 196 N.Y.Y L.J No. 108, p. 18), New York held the part of the capital gain up to the spread at exercise should be allocated by the days worked method. The taxpayer needs to determine the rules for the states in which he or she is working and is a resident.)

When an employee was a non-resident of California when granted a non-qualified stock option then moves and exercises the option when the employee is a resident of California, all of the income is taxable in California.

When an employee was a non-resident of California when granted an incentive stock option then moves and makes a disqualifying disposition when the employee is a resident of California, the ordinary compensation income is taxable in California.

(Note -- When an employee is taxed on the same income in two states, the employee may be entitled to a state tax credit. You have to study the tax laws of the states you are dealing with to find out which state allows the credit. )

In the article, a very brief description was given of the alternative minimum tax results of exercising an incentive stock option. How the California AMT is computed when an employee changes residence was not discussed.

It seems to me that, since the incentive stock option provisions don’t apply when computing the AMT, the tax preference should be allocated as compensation income is for non-qualified options. California AMT can be imposed on California-source income of non-residents. The problem with this is, since California considers a capital gain to be taxable in the state of residence, the employee who meets the holding period requirements won’t be able to recoup the California AMT credit when the stock is sold, so there will probably be a California AMT in the year of exercise and a tax in the state of residence when the stock is sold, with no AMT credit and no state tax credit. This interpretation for incentive stock options has not been clearly stated, and other tax advisors disagree with me about this.

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Consult with a tax advisor

For our readers who aren’t tax advisors, this newsletter is intended to alert you about tax issues that could affect you. It is not a substitute for advice from a professional tax advisor. You will find that getting advice from a qualified advisor is a worthwhile investment. We intend to eventually publish a directory of ESOAA members who are committed to helping clients with employee stock option issues.

Tax advisors should view the newsletter as an alert to become aware of issues relating to employee stock options for further research and study.

(Michael Gray is the co-author of Employee Stock Options – A Strategic Planning Guide for the 21st Century Optionaire. You can order the book at http://www.amazon.com or http://www.barnesandnoble.com/ or buy it at Stacey’s Books.)

P.S.

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