Michael Gray, CPA’s Option Alert #63

An irregular alert for issues relating to employee stock options

December 10, 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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Happy Holidays!

2008 will soon be a memory. Many people will be glad to see this year end. Remember that anyone with health, family and friends has a lot to be thankful for.

We hope you enjoy a Happy Holiday season despite the scary economic news. If you are well-off financially, we hope you are able to give generously to help those who are less fortunate than you are. If you aren’t so well off this year, we hope next year will be a much better one for you.

Our office will be closed on Christmas Eve day, Christmas day and New Years day.

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Now is the time for year-end planning

There are a limited number of year-end planning appointments available. Make your reservation now by calling Dawn Siemer at 408-918-3162.

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Year-end tax planning for employee stock options telephone conference

Michael Gray will present a telephone conference about year-end tax planning for employee stock options on Friday, December 19 from 1 p.m. to 2:30 p.m. Pacific Time. To get the details and reservation form, call Dawn Siemer weekday afternoons at 408-918- 3162.

This is the only live presentation Michael Gray will make before the end of 2008.

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If you exercised ISOs during 2008, should you use the “escape hatch”?

Remember if you exercised ISOs during 2008 and didn’t sell the stock, your AMT adjustment will be based on the fair market value of the stock on the date of exercise. However, if you sell the stock before the end of the year of exercise, the AMT adjustment is eliminated. Ordinary income is reported for the excess of the selling price over the option price. I call this strategy “the escape hatch.”

For example, Jean Employee exercised an ISO for 1,000 shares of XYZ stock on March 1, 2008. The fair market value of the shares on March 1, 2008 was $55 per share and the option price was $5 per share. If Jean didn’t sell the stock, she would report additional AMT income of $55 – $5 = $50 X 1,000 shares = $50,000. On December 15, 2008 Jean sells the stock for $15 per share. The AMT adjustment is eliminated and Jean reports $15 – $5 = $10 X 1,000 shares = $10,000 of ordinary income for regular tax and AMT.

There is an important requirement to get this tax benefit. A loss would have to be “allowable” if the stock was sold at a loss. A common transaction that would disqualify an escape hatch is a wash sale. A wash sale happens when replacement shares or an option to acquire replacement shares are acquired during the period 30 days before or 30 days after the sale.

For example, if Jean purchased 1,000 shares of XYZ Software for $16 per share on December 10, 2008, she would still have a disqualifying disposition of the ISO shares, but she would have $50,000 or ordinary income because the escape hatch wouldn’t apply. Her short-term capital loss of $15 – $55 = $40 X 1,000 shares = $40,000 would be disallowed as a current deduction. The disallowed loss would be added to the tax basis of the replacement shares. Therefore, the tax basis of the replacement shares would be $16 + $40 = $56 X 1,000 shares = $56,000.

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Refundable AMT credit change simplifies year-end planning

Remember that changes adopted as part of the October 3, 2008 “bailout” legislation eliminated the phaseout of the refundable minimum tax credit based on adjusted gross income. That won’t be a concern for your 2008 tax planning. (Thank God!)

Also, since many taxpayers will qualify to receive the refundable minimum tax credit for 2008 who couldn’t receive it before, they can reduce or eliminate their final estimated tax payment for 2008. Merry Christmas!

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Consider a “thank you gift” to Reform AMT

Thanks to the efforts of volunteers at Reform AMT, many of you will receive a refund for 2008 based on your federal minimum tax credit that you weren’t able to use before. This effort required hiring lobbyists who haven’t been paid yet. It took eight years of patient work to get effective relief legislation passed.

Please consider making a year-end non-deductible donation to Reform AMT as a thank you gift for this effort.

If you can’t afford it now, consider sharing part of your 2008 refund when you receive it.

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Potential suit under SEC Rule 16(b) postpones income for option exercise

A U.S. District Court issued a summary judgment partially in favor of a taxpayer to postpone the recognition of income for the exercise of a non-qualified stock option.

The taxpayer exercised the options in 1999 and 2000 and reported the income based on the exercise dates.

She filed a claim for refund based on the reasoning that she was subject to SEC Rule 16(b) requiring disgorging profits for six months after the vesting dates for the options.

The Court found that the SEC rules for the application of Rule 16(b) clearly state that the restriction applies for six months after the grant dates for the options.

However, the Court accepted an alternative theory of the taxpayer that she was subject to a substantial risk of forfeiture because it was reasonable to believe she would be subject to a lawsuit as subject to disgorgement under Rule 16(b) until six months after the dates the options vested. At the time she exercised the options, the rules appeared to be sufficiently unclear to be subject to a lawsuit.

Therefore, the income was reportable in 2000, six months after she terminated employment with the company and the options stopped vesting.

Since the statute of limitations is now closed for 1999 and 2000, it is unlikely any claims for refund can be filed based on this case. If the tax liability hasn’t been paid for those years, an offer in compromise could be filed based on doubt as to liability.

(Since Rule 16(b) only applies to certain corporate insiders, the exception providing a substantial risk of forfeiture under that rule has a very limited applicability. Most other temporary limitations for trading shares, such as “lockout periods,” are disregarded and don’t qualify as a substantial risk of forfeiture.)

(Strom v. U.S., DC-W.D. Wash., October 15, 2008, 2008-2 USTC 50,632.)

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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”.


I had a significant AMT tax bill from some 1999 stock options. I am aware of the federal tax refund law that went into effect in 2007. I think it is a refund of 20% per year for a six year period.

I have written to my California State Senator, Congressman and the Governor about having California adopt the refundable minimum tax for California, but I get the runaround with no answers. They still have my money.

Do you have any information about state tax laws adopting the refundable minimum tax credit?


Only a few states have an alternative minimum tax that includes the ISO adjustment.

California hasn’t conformed to the federal law adopting a refundable minimum tax credit, and I don’t expect it to. The reason, plain and simple is the budget. California can’t continuously generate deficits at the same level that the federal government can.

Usually it’s easier to recover the minimum tax credit for California under the “traditional rules” than on your federal income tax return because California taxes long-term capital gains at 9.3% while the AMT rate is 7%, so if you sell the stock for at least the fair market value on the date of exercise, you’ll recover the California minimum tax credit.

The difference between the 9.3% regular tax and 7% AMT tax will also enable most people to recover some of their California minimum tax credit each year.

It may be some other strategies will help you recover your California minimum tax credit. Call me at 408-918-3161 if you want to discuss this in more detail.

I have some good news for you. The federal refundable minimum tax credit has been increased to 50% for 2008! See the article, “Refundable minimum tax credit available for 2008.”

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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