Michael Gray, CPA’s Option Alert #58

An irregular alert for issues relating to employee stock options

August 6, 2008
© 2008 by Michael Gray, CPA
ISSN 1931-2768

(If you find this information valuable, please pass it on to a colleague!)

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Janet and I (Michael Gray) will be vacationing at Waikiki starting August 23. I’ll return to the office on September 1. If you need help with a tax issue in my absence, call Thi Nguyen, CPA at 408- 918-3163. For help with an administrative issue or to make an appointment for when I return, call Dawn Siemer on a weekday afternoon at 408-918-3162.

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Do you need help preparing extended income tax returns?

Time marches on! The extended due date for 2007 calendar year corporate income tax returns is September 15, 2008. The extended due date for 2007 calendar year individual, partnership, estate and trust income tax returns is October 15, 2008.

If your 2007 income tax returns aren’t done yet and you are seeking help from a tax return preparer, call Dawn Siemer on a weekday afternoon for an appointment at 408-918-3162.

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Do you have an estate plan?

Although having a will and/or living trust is critically important, there is more to an estate plan than documents. What will the estimated cash requirements be for estate taxes, paying off debts and final expenses? How will your final expenses be paid? How should your retirement accounts be handled? Will your family be left in financial distress? Is there a succession plan for your business? Do you have a charity that you would like to provide for? If you would like our help in exploring these issues, please call Dawn Siemer for an appointment on a weekday afternoon at 408-918-3162.

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Michael Gray gives a telephone employee stock options seminar on August 21

Michael Gray will be giving a telephone “Secrets of Tax Planning For Employee Stock Options” seminar at 1 p.m. Pacific Time on August 21. For details and to make reservations, call Dawn Siemer on a weekday afternoon at 408-918-3162, or email eso-advisors@stockoptionadvisors.com.

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Proposed regulations issued for employer report of ISO and ESPP exercises

The IRS has issued proposed regulations for an information report to be submitted by employers when an Incentive Stock Option (ISO) or an Employee Stock Purchase Plan option (ESPP) is exercised. The reporting requirement was enacted in the Tax Relief and Health Care Act of 2006.

The IRS will soon issue Form 3921, Exercise of an Incentive Stock Option, and 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c).

These forms will be required to be submitted to the IRS no later than January 31 of the calendar year following the date of exercise. Employers will be able to apply for a one-month extension of time to file the forms.

The information required to be submitted to the IRS is generally the same information already required to be reported to employees under the existing regulations.

The proposed regulations would be effective starting calendar year 2009. Employers may optionally use the forms for calendar year 2008. Meanwhile, the information is still required to be provided to employees.

This information will be especially valuable to the IRS to audit whether employees are reporting additional income for the exercise of incentive stock options on the alternative minimum tax form.

(REG-103146-08, 73 Fed. Reg. 40,999, July 17, 2008.)

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IRS issues proposed ESPP regulations

The IRS has issued proposed regulations for Employee Stock Purchase Plans.

The regulations mostly provide the guidelines for employers in administering the plans. Since they are mostly employer-oriented and don’t have any substantive changes for employees, I’m not going to discuss them in detail.

Here are a few highlights to be aware of:

  • The plan and terms of an offering must be in writing or electronic form.
  • The terms of an offering for all employees must be the same. If different terms are offered to one employee, the entire plan will be disqualified and the grants will be of non-qualified stock options. The employer may avoid this issue if the plan, by its terms, permits all eligible employees to elect to participate in the offering.
  • If there are any substantive changes in a plan, including changing offering subsidiary stock to employer stock, the changes must be approved by the shareholders within 12 months before or after the change.
  • The plan of a 100%-owned subsidiary corporation must be approved by its shareholders, which is the parent corporation, not the shareholders of the parent corporation.
  • Formulas are specified to define the maximum aggregate number of shares available for grants under a plan, and the increases for each year.
  • Non-resident aliens who receive no US-source income may be excluded from participating in the plan providing complying with the laws of their countries of residence would violate the requirements for ESPP plans or the laws of the foreign jurisdiction prohibit granting an option under such a plan. For example, if the laws of the country of residence require that options granted to the employee must be transferable during his or her lifetime, those laws violate the requirements for ESPP plans, so employees who are subject to the laws of that country may be excluded from participation in the plan.

The proposed regulations would be effective as of January 1, 2010 provided that they are issued as final regulations on or before that date.

(REG-106251-08, 73 FR 43875, July 29, 2008.)

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Leaving the United States could be very expensive

As part of the Heroes Earnings Assistance Tax Act of 2008, enacted on May 22, 2008, renouncing your U.S. citizenship or leaving the U.S. after a long period of “permanent residency” may be a taxable event. The taxpayer is treated as selling their property for fair market value on the day before their expatriation date. Any gain exceeding $600,000 is taxable at the time the individual leaves the U.S. or renounces his or her U.S. citizenship.

The “deemed sale” applies to a “covered expatriate” if the individual (1) has an average annual net income tax liability for the five preceding years ending before the date of the loss of U.S. citizenship or lawful permanent residency that exceeds $124,000 adjusted for inflation, or $139,000 for 2008; (2) has a net worth of $2 million or more on that date; or (3) fails to certify under penalties of perjury that he or she has complied with all U.S. tax obligations for the preceding five years or fails to submit evidence of compliance as required by the IRS.

A “covered expatriate” includes a U.S. citizen who gives up his or her citizenship and any long-term U.S. resident who ceases to be a lawful permanent resident of the United States. A long-term U.S. resident is defined as an individual who was a lawful permanent resident (green card holder) for at least eight of the last 15 tax years ending with the year the individual ceases to be a lawful permanent resident.

There are limited exceptions to the rules for certain dual citizens and for minors.

Since there are so many resident aliens working in the United States, including many high-paid professionals, this new law could have a widespread impact. Since they aren’t able to vote, you could say this was a form of taxation without representation.

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Questions and Answers

To our readers:

The answers to many of your questions can be found in our free reports, “Executive Tax and Financial Planning For Non-Qualified Stock Options” and “Executive Tax and Financial Planning For Incentive Stock Options”.


If a beneficiary exercises an ISO (cashless) after receiving the transferred shares in the same year as the death of the employee, how is that reported? Is it treated like an NQO (reported on the employee’s W-2 for social security and Medicare and 1099-Misc for the beneficiary)?



As long as the employee met the requirements for an ISO at the date of death, the option continues to qualify as an ISO after death, and the holding period requirements and the requirement that the holder should be an employee at the time of exercise or the option is exercised within three months after leaving employment are eliminated. (Internal Revenue Code Section 421(c)(1)(A).)

Employment taxes don’t apply to the exercise of an ISO.

The AMT adjustment will still apply to the exercise.

You can find answers to questions like these in Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs, 2nd Edition. It is available at or at Amazon.com.


Employee A leaves Company X and has 1.25 shares vested of NQSO. Company X is in the process of being sold. If Employee A exercises the option, does the employee have to pay the taxes immediately on the excess of the fair market value over the option price of the stock, or can the company withhold the tax when the sale is consummated or issue a 1099?


The withholding is due at the time of exercise.

An exercise of an NQO issued during the employment of a former employee should also be reported on Form W-2. It is subject to withholding and employment taxes. The ordinary income from these transactions should not be reported on Form 1099.

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 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 now offering our real estate tax newsletter, Michael Gray, CPA’s Real Estate Tax Letter, free of charge. Like this newsletter, we will talk about new developments, have reports on special tax concerns, and answer questions and answers. To subscribe and read 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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Subscribe to Michael Gray, CPA’s Option Alert!

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.

(Michael Gray is the author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)

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