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By Michael Gray

Table of Contents

• Action may be required by December 31, 2005 for some non-qualified stock options
• Do you know about our other newsletter?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert

Action may be required by December 31, 2005 for some non-qualified stock options

In Option Alert # 23 issued on December 12, 2005, I highlighted the problems of non-qualified options under the new rules for non-qualified deferred compensation plans. Under the new rules, if a non-qualified stock option is granted with an option price below the fair market value of the stock on the date of exercise (in the money), the option may be subject to the new rules for deferred compensation. Under these new rules, the deferred income may be accelerated, even when the option isn't exercised, and a 20% penalty tax may be imposed on the ordinary income from the option.

Under transitional rules, NQOs that were granted and vested before January 1, 2005 are exempt from the rules.

"In the money" NQOs that were granted but not vested before January 1, 2005 may be subject to the rules. Employers can modify the NQO agreement to meet the new requirements by December 31, 2006. If the employee exercises his or her option before the agreement is modified, the option may still be subject to the rules.

There is another important exception. When an "in the money" NQO that would otherwise be subject to the rules is exercised by December 31, 2005, the option is exempt from the new rules. (Notice 2005-1, Question and Answer 20.) Thanks to attorney Stephen Harris at Paul, Hastings, Janofsky & Walker, LLP (www.paulhastings.com) for his input on this issue.

Therefore, if you had an NQO that was "in the money when granted", including all NQOs granted by non-public companies, the NQO was granted and unvested before 2005, you should consider exercising the NQO by December 31, 2005.

Please consult with your own tax advisor about your situation before going ahead.

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

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Do you know about our other newsletter?

For general tax developments, tax planning ideas, business development ideas and book reviews, subscribe to Michael Gray, CPA's Tax & Business Insight.

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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.

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 www.amazon.com or www.barnesandnoble.com or buy it at Stacey’s Books.)

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