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By Michael Gray

Table of Contents

• Third estimated tax installment due September 16
• Special capital gains election revisited
• Become an ESOAA web site subscriber
• Questions and Answers

  How is fair market value determined for private companies?

  Can I get my ISO exercise deadline extended?

• Consult with a tax advisor

Third estimated tax installment due September 16

The due date for the third estimated tax payment for individuals and calendar-year corporations is September 16, 2002. With an expected decline in income, many taxpayers didn't base their 2002 payments on their 2001 tax. It may be the estimated tax payment should be adjusted based on the changes in your income or deductions for this year. Please see your tax advisor if you need help with this.

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Special capital gains election revisited

Remember an election is available to treat capital assets or business assets as sold and re-purchased at the beginning of 2001. This election may be made on an original income tax return or on an amended income tax return no later than six months after the original filing due date (October 15 for individuals).

The purpose of the election is to qualify the assets for a new 18% maximum capital gains rate for assets held more than five years for assets acquired after December 31, 2000. The election may be made on an asset-by-asset basis.

We recommend the election should be considered when there are tax attributes, including unused capital losses, minimum tax credits, net operating losses and passive activity losses that can be used to reduce or eliminate the tax for the deemed sale. If you have one or more of these, you should meet with your tax advisor to determine whether you should make the election by October 15, 2002. (Notice 2002-58.)

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Become an ESOAA web site subscriber

We have finally converted our web site to a subscription basis. Certain "sample" material, including the current issue of the ESOAA Option Alert will be free. The archive of ESOAA Option Alerts and posted questions and answers are in the subscribers-only section. For details and to subscribe, go to http://www.stockoptionadvisors.com/subscribe.shtml. Your support as a subscriber will help us continue to provide you with this vital information!

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Questions and Answers

Question

When stock options are exercised in a startup company (not publicly traded), how is the "fair market value" determined?

I believe the price quoted by the company can be reduced to determine the AMT based on marketability and conditions on selling the stock.

Answer

The employer should be providing the fair market value of the stock at exercise. According to Internal Revenue Code Section 422(c)(1), a good faith effort to value the stock by the employer will be honored. Remember the option price may not be less than the fair market value of the stock when the option is granted.

According to Section 83(a)(1) (which applies for the AMT adjustment) and Section 422(c)(7) (which applies under the ISO rules), the fair market value of stock is determined without regard to any restriction other than a restriction which, by its terms, will never lapse. Treasury regulations Section 1.83-3(h) defines a nonlapse restriction as a permanent limitation on the transferability of property (i) which requires the transferee of the property to sell, or offer to sell, the property at a price determined under a formula, and (ii) which will continue to apply and be enforced against the transferee or any subsequent holder (other than the transferor). An example is a right of first refusal at a formula price.

If you are going to challenge the value provided by the employer, you will need to substantiate the value you use. The proper way to do this is through a business valuation/appraisal process that is very expensive, time consuming and will require the cooperation of your employer's accounting department.

(Yuck!)

Question

I own 20,000 ISOs of a NASDAQ stock at a $4.86 strike price. I was laid off on June 6, 2002 and the company has a 3-month exercise requirement from date of separation, which means I have to exercise by September 6. The stock was at $9 when I was laid off. I held, hoping it would go up. The stock is at about $3.80 now.

Any precedent for extending the 3 month window into a longer time period? Any other advice? It looks like the options will be under water for a while.

Answer

Just because you are granted options doesn't mean you are guaranteed to benefit from them.

Employee stock options can't qualify as incentive stock options three months after you leave employment with the company that granted them. The employer can extend the term of the options, but they will be converted to non-qualified stock options.

Changing the terms of the options could create an accounting issue for your employer.

It would be nice if they offered you a severance package in appreciation for your contributions to the company.

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Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter.

The answers to most questions can be found in our course, "Secrets of Tax Planning For Employee Stock Options". For details write Dawn Gray at info@stockoptionadvisors.com.

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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.

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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.

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(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.

To receive the next issue of Michael Gray, CPA's Option Alert with more employee stock option tax developments and answers to questions from our readers automatically via email, subscribe by filling out the form below.