How can I lower my taxes if my stock options have declined in value?

July 27, 2001

Subject:   tax implication of ISOs
Date:   30 Mar 2001
From:   Ramki

Dear Sir or Madam:

I would appreciate if someone can answer my following question:

I was granted 2000 stock options at a strike price $X in January 1998,
I exercised them last June when the fair-market value (FMV) was $YY a share, and
I sold all this stock at a FMV $ZZ a share November 2000.

Is this the correct interpretation of the current tax law?

I seem to have the “disqualifying disposition.”
Therefore, to my regular salary I add N,000 * (YY-X)=$##,###.
When I sold the stock, I suffered capital losses, but I can only deduct $3,000 per year.

So, I end up paying taxes on $##,### even though I have a net gain of only $N,000 on my options?

Thanks in advance,


Date:   Wed, 25 Jul 2001

Hello Ramki,

Based on the information that you have provided to me, it appears you may be eligible for a tax relief provision that I call the escape hatch.

According to Internal Revenue Code Section 422(c)(2), if the stock received from exercising an incentive stock option is sold during the year of exercise, the ordinary income is limited to the excess of the selling price of the stock over the option price.

In order to qualify for the limitation, the disposition must be a sale or exchange with respect to which a loss (if sustained) would be recognized to the individual. A concern that was widely discussed during late 2000 is the wash sale rules could make the escape hatch unavailable. So if you repurchased employer stock within 30 days before or after the sale of your option stock, you may not be eligible for this relief.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options – Executive Tax and Financial Planning Strategies.

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