Michael Gray, CPA’s Option Alert #67

An irregular alert for issues relating to employee stock options

April 6, 2009
© 2009 by Michael Gray, CPA
ISSN 1931-2768

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

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Only 12 days left in tax season! Time to think about extensions.

There isn’t enough time left to give preparing tax returns the attention they deserve, but we can help a few more new clients with extensions and finish their returns later. To make an appointment, please call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Our office was burglarized.

When I arrived at our office last Saturday morning, I discovered that someone broke into our office through the back door and stole three computers.

The theft has been reported to the San Jose Police Department.

Fortunately, our server, where we store almost all of our confidential information (including computerized tax processing files), was left undisturbed. Our “hard copy” client files also were undisturbed.

There was some information, including email messages and attachments, that might be accessible on the computers, so please watch for any unusual activity. We do not have any credit card information on our computers.

We are praying the thieves were teenagers who will just wipe the hard disks, but we don’t know.

We plan to get a burglar alarm system in place and the landlord is having the doors reinforced to avoid break-ins in the future.

We have a recovery plan, have already replaced the computers, and continue to process income tax returns to conclude tax season. (How fast would you recover if you had a similar experience?)

The security of your information is important to us and we apologize for any disruption or concern you experience as a result of this incident.

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Michael Gray gives a briefing on new federal tax legislation.

I will be giving a two-hour breakfast briefing about the American Recovery and Reinvestment Act of 2009, otherwise known as President Obama’s economic stimulus legislation, at the Los Gatos Lodge in Los Gatos, California. Although the seminar is for the Silicon Valley San Jose chapter of the California Society of CPAs, others who are interested may also come, including attorneys, financial planners and professional fiduciaries. Registration is at 7:45 a.m. and the presentation will start at 8 a.m. Pre-registered investment is $45 for members, $23 for student and candidate members, and $55 for non-members. To register or for more information, call Stephanie Stewart at 408-983-1122.

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Michael Gray is interviewed in the media.

I have had several media appearances recently to promote the Real Estate Tax Handbook. One was an interview on the Financial Lifeline Radio.

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Michael Gray, CPA is now on Facebook.

Want updates on our upcoming events and media appearances? Michael Gray, CPA is now on Facebook. Become a fan and be the first to hear about what’s new.

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Extensions – and when you don’t have the money to pay the tax.

(This is a reprint from past newsletters.)

What do you do when you don’t have the money to pay the tax?

My first recommendation is to file your income tax returns, certified mail, by the initial filing date. One of the nastiest penalties in the IRS’s arsenal is for late filing – 5% per month to a maximum of 25%. Some people who owe money don’t file their returns because they are afraid. THIS IS A HUGE MISTAKE! The best approach is to be honest about your situation and work with the tax authorities to resolve it.

When you file an extension, any balance of tax due when the tax return is filed represents an exposure for the late filing penalty.

Please don’t misunderstand me. I regularly use extensions for my clients and myself as a workload “safety valve.” We often don’t have the information to complete a return by the due date. They just aren’t appropriate when there will be a significant balance due that won’t be paid by the original filing due date.

Remember the automatic extension of time to file for 2008 individual income tax returns is for six months to October 15, 2009.

Remember to state a good (high side) estimate of total tax liability for 2008 on line 4 of federal Form 4868 or the extension will be invalid. According to the Treasury regulations for the requirements to file a valid automatic extension request, “an application for extension must show the full amount properly estimated as tax for the taxable year.” (Reg. § 1.6081-4(a)(4).) The regulations relating to reasonable cause for failure to file a tax return state that if a taxpayer satisfies the requirement of showing the full amount estimated as tax, the taxpayer has a reasonable cause for failure to file during the extension period provided (1) the excess of the amount of tax shown on the return over the amount of tax paid by the original filing date (including the amount paid with the extension form) is no greater than 10 percent of the amount shown on the return (restated, 90% of the tax is paid by the due date), and (2) any balance due shown on the return is paid with the return. (Reg. § 301.6651-1(c)(3).)

(For California taxpayers, the extension is paperless so the amount of the tax need not be stated. You are still required to pay at least 90% of the tax by the original due date with Form FTB 3519 to avoid the late filing penalty.)

If you have filed an income tax return for 2007, you can process your federal extension electronically (using tax return preparation software or through a tax return preparer). If you make a tax payment using a credit card, you can extend your income tax return by calling 888-729-1040 or 800-272-9829 by April 15. (For California extension payments, the extension is 1555.) Better call early to beat the rush! Mailing a paper form is still acceptable and is the only way a person who didn’t file a 2007 income tax return can request an automatic extension.

You can also make a credit card payment online at www.pay1040.com or www.officialpayments.com. California also has a web payment option at www.ftb.ca.gov.

A taxpayer can still avoid the late filing penalty by demonstrating a “reasonable cause,” but this can be a hassle and the taxpayer is at the mercy of the subjective judgment of a representative of the tax authority.

Should you borrow using a margin account? In most cases, this is not a good choice because of the exposure to margin calls if the market declines.

Should you use an equity advance loan, secured by your principal residence? In some cases it might be to your advantage, if you can get a favorable interest rate. Remember that interest for an equity loan not used for a home improvement is only deductible on a loan amount up to $100,000. This interest is not deductible when computing the alternative minimum tax.

Remember that IRA accounts and even other retirement accounts can be temporary sources of funds. Distributions from IRAs that aren’t minimum required distributions can be rolled over to another IRA or returned to the same IRA within 60 days after a withdrawal. This exception only applies to one rollover per year. (You must wait more than one year after a rollover is completed before making another one.)1

Certain distributions from other qualified plans can also be rolled over within a 60-day period to an IRA or another qualified plan.2 Using IRAs or qualified plans as a temporary source of funds to pay taxes can be useful if the funds to complete the rollover will soon be available, such as when there is a lockout “window” that will soon be open. The cost of an error can be high, because if the rollover isn’t completed before 60 days have expired, the distribution may be subject to tax as ordinary income plus a 10% early distribution penalty.3

The IRS has a form for installment agreements, Form 9465. They would prefer that you submit the form with your income tax return. You can take up to five years to pay off your tax liability. An advantage of arranging an installment agreement is the penalty for late payment of tax is reduced from 1/2% per month to 1/4% per month. In addition to penalties, interest is charged for late tax payments. The interest rate is adjusted quarterly. Recently, the rate has been eight percent.

Another alternative is to make an Offer in Compromise, Form 656. With this procedure, the IRS actually can reduce your tax based on your ability to pay. You don’t have to wait until you have owed the tax a long time to use this procedure. I think it’s best to work with an attorney, CPA or enrolled agent when making an Offer in Compromise. If the amount is large, an attorney is probably the best choice. (This may be an exercise in futility. The IRS has recently been rejecting almost all offers. You are required to make a non-refundable deposit of 20% of the compromised tax in most circumstances. It’s sad, because taxpayers really need this relief.)

Although it may provide relief from your other creditors, bankruptcy doesn’t offer much help for recent debts for income taxes. When you make payments on your tax bill, be sure to specify to apply the payments to taxes due. Penalties and interest are dischargeable in bankruptcy, but income taxes aren’t.

It may be to your advantage to plan how to use regular tax or alternative minimum tax capital loss carryovers or minimum tax credit carryovers. You might need to generate capital gains, which can be difficult when you’re in financial distress.

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First individual estimated tax payment is due April 15.

(This is a reprint from past newsletters.)

Remember to review your estimated tax situation for 2009.

There is no estimated tax penalty provided the taxpayer pays at least 90% of the tax (including AMT) on the current year’s tax return through withholding and/or equal quarterly estimated tax payments.

For taxpayers who have no more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year’s income tax return, there is no penalty for underpayment of estimated tax provided at least the income tax on the previous year’s income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.4 For taxpayers who have more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year’s income tax return, there is no penalty for underpayment of estimated tax provided at least, for 2008, 110% of the income tax on the previous year’s income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.5

Remember California now requires 30% of the estimated tax liability to be paid for each of the first two quarters of 2009 and 20% each for the last two quarters. Taxpayers who have uneven income and deductions may also compute their estimated tax on an “annualized” basis. You multiply the year to date income and deductions to arrive at amounts for a year, compute the tax for that amount, then pay amounts to cumulatively pay in 1/4, 1/2, 3/4 and 100% of those amounts. You should probably get help from a professional tax return preparer to do this.

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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 exercised an NQO with a stock swap and found your information to be useful. Please confirm that the exercise is currently taxable. I didn’t receive a 1099 form, but the income is reported at Form W-2, line 12(c). I need to know the process of dealing with the tax treatment for the current year and in the later year when I sell the swapped option shares.


I assume the options were fully vested when they were exercised. The exercise of the NQO is currently taxable, and has evidently already been included in your wages on Form W-2. There is nothing more to do for the year of exercise.

The shares that were “swapped” retain their tax basis and holding period. The additional shares received have a tax basis equal to their fair market value on the date of the exchange and the acquisition date is the date the option was exercised. There are examples in our FAQs and in my book, Secrets of Tax Planning For Employee Stock Options.


When my employer granted my initial options in 1997, I was given a letter showing they took $8,000 of my annual compensation and converted it into stock options. Since this amount was not reported on my W-2 for that year, did I really pay for these options and does this establish a cost basis for the options, or did my employer simply use a notional amount to calculate how many options they would grant, and then add that “value” to my cash compensation to come up with my total compensation?


Since you reported no compensation income for the options you received, they had no tax basis or “cost.” Personally, I think the “value” your employer showed on that statement was nonsense.


On May 2, 2008, I exercised an ISO for 25,000 shares with a per share option price of $19.00 and fair market value of $140.47.

When I exercised the option, I swapped 2,820 shares with a tax basis of $136.85 and 561 shares with a tax basis of $12.75, plus cash of $79.24. These shares came from previous stock grants and options that were held for the time required for a qualified disposition.

On November 13, 2008, I sold 10,000 shares at $79.24 per share in a disqualified disposition. I am still holding the remaining shares.

What tax basis do I use to calculate the disqualified disposition?


Zero. The tax basis stays with the original shares that you “swapped.” Only the cash paid of $79.24 is assigned to the shares you received.

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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1 Internal Revenue Code § 408(c)(3) RETURN
2 Internal Revenue Code § 402(c) RETURN
3 Internal Revenue Code § 72(t) RETURN
4 Internal Revenue Code § 6654(d)(1) RETURN
5 Internal Revenue Code § 6654(d)(1)(C) RETURN

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