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Table of Contents

• IRS will look at backdated stock option awards
• PCAOB tells auditors to look at stock option grants
• No penalty when deferred compensation paid under federal certificate of divestiture
• Withholding for supplemental wages over $1 million
• Capital loss limit applies for AMT
• IRS rejection of offer in compromise on AMT upheld
• Questions and answers
  • When is compensation for stock options considered received?
• Do you know about our other newsletters?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert

IRS will look at backdated stock option awards

IRS Commissioner Mark Everson has said that IRS agency staff will consult with the Securities and Exchange Commission "to determine which companies merit scrutiny" for tax issues associated with backdating employee stock option awards.

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PCAOB tells auditors to look at stock option grants

The Public Company Accounting Oversight Board has issued Staff Audit Practice Alert No. 1, Matters related to timing and accounting for option grants. The Staff Practice Alert advises to auditors of financial statements for public companies to pay special attention to whether there has been backdating of stock options and provides guidance about issues to consider relating to whether adjustments or disclosure is required.

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No penalty when deferred compensation paid under federal certificate of divestiture

The IRS has issued Notice 2006-46, about whether the 20% penalty tax for early distributions under a non-qualified deferred compensation plan under §409A applies when the payments are made to satisfy federal conflict of interest requirements.

According to the IRS, payments made under a written determination by the Office of Government Ethics stating that the divestiture or termination of financial interest is reasonably necessary to comply with federal conflict of interest requirements and specifying the applicable financial interest are not subject to the penalty tax. Previously, the payment had to be made under a certificate of divestiture. Now other written guidance is acceptable.

Of course, the amounts paid are included in taxable income.

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Guidance issued on withholding for supplemental wages over $1 million

The IRS has issued final regulations explaining flat rate withholding for supplemental wages over $1 million. The rate for these wages was increased to the maximum individual income tax rate (35%) for wages paid after December 31, 2004 by the 2004 Jobs Act.

The final regulations apply for wages paid on or after January 1, 2007.

Supplemental wages include any wages paid by an employer that are not regular wages. Regular wages are amounts paid by an employer for a payroll period either at a regular hourly rate or in a predetermined fixed amount. Supplemental wages include commissions, tips, and bonuses. (Income from non-qualified stock options are treated as bonuses.)

The final regulations eliminate a requirement in proposed regulations that a payment can qualify as supplemental wages only if regular wages have been paid to the employee. Therefore, if an employee's wages for a calendar year are only from the exercise of a non-qualified stock option, the income is supplemental wages.

The final regulations permit employers to treat tips and/or overtime pay as regular wages. That treatment doesn't have to be applied to all employees.

Income tax must have been withheld from the regular wages of the employee in order for the optional flat rate withholding to be available.

(T.D. 9276.)

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Capital loss limit applies for AMT

A U.S. District Court held that losses from stock acquired from exercising incentive stock options are subject to the same limit that applies for regular tax reporting - capital gains plus $3,000.

The Court cited a Tax Court decision in Merlo, (126 TC No. 10) and the General Explanation of the Tax Reform Act of 1986 by the Joint Committee on Taxation in finding the capital loss limit applies for AMT reporting.

(Paul Norman v. U.S., (DC Cal 07/19/2006) 98 AFTR 2006-5191).)

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IRS rejection of offer in compromise on AMT upheld

The Eighth Circuit Court of Appeals has affirmed a Tax Court ruling that the IRS did not abuse its discretion in rejecting a taxpayer's offer in compromise relating to an AMT liability resulting from the exercise of ISOs.

Ronald J. Speltz exercised incentive stock options during 2000, resulting in an AMT of $206,191. After 2000, the stock had a steep decrease in value.

Mr. Speltz made partial payments of his 2000 tax liability and made an offer in compromise, based on doubt as to collectibility, to pay the $4,457 cash value of his life insurance policy against the $125,000 balance of his tax liability.

The IRS rejected Mr. Speltz's offer.

Mr. Speltz contested the IRS's decision in Tax Court. He said the IRS abused its discretion because of doubt as to collectibility and because it wasn't promoting effective tax administration. He said the IRS overestimated his ability to pay the tax.

The Tax Court held in favor of the IRS and the Eighth Circuit affirmed the Tax Court's decision. The Eighth Circuit said the Tax Court wasn't asked to recompute Mr. Speltz's ability to pay the tax. They suggested that Mr. Speltz should submit another offer in compromise and, should there be a dispute about his ability to pay, appeal the new decision through the IRS and Tax Court.

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Questions and Answers

Question

Would you say that a person who is granted options on January 1, 2000 and exercises and sells on January 1, 2005 receives compensation on January 1, 2005 or January 1, 2000?

Answer

Assuming the options are non-qualified stock options, fully vested on January 1, 2005, that is the date that taxable compensation is received.

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

We do not provide free technical support for TurboTax!

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Do you know about our other newsletters?

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

We are starting a newsletter devoted to real estate tax issues - Michael Gray, CPA's Real Estate Tax Letter. Like this newsletter, we will talk about new developments, have reports on special tax concerns, and answer questions and answers. The subscription rate is $19.95 per month. For a sample issue, visit realestatetaxletter.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.

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.)

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.

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