Michael Gray, CPA’s Option Alert #71
An irregular alert for issues relating to employee stock options
August 7, 2009
© 2009 by Michael Gray, CPA
(If you find this information valuable, please pass it on to a colleague!)
Table of Contents
- Discounted stock options aren’t performance-based pay
- Michael Gray, CPA suffers from a rash of summer vacations
- No deduction for redemption of ESOP stock
- No million $ cap for compensation under pre-IPO agreement
- Tune in for Financial Insider Weekly
- IRS says it can seize non-transferable options
- Employer deduction changes proposed for ESOs
- California withholding and estimated tax will be messy
- Questions and Answers
- 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 Deputy Associate Chief Counsel says discounted stock options aren’t performance-based pay
Alan Tawshunsky, IRS Deputy Division Counsel, has issued a memorandum stating the opinion that employee stock options priced below the fair market value of the stock on the grant date are not performance-based compensation. Therefore, employers that are publicly traded corporations won’t be able to deduct discounted option-based compensation for an executive when total compensation exceeds $1 million.
The corporation and employee can’t “cure” the option by repricing it at a later date or by the employee reimbursing the corporation for the “disqualified” amount. Whether the option qualifies as performance-based pay is determined on the grant date of the option.
(AM 2009-006, 2009ARD 137-2, July 20, 2009.)
Michael Gray, CPA suffers from a rash of summer vacations
As things have developed, Dawn, Thi and I are going to have some overlap for our vacations. Janet and I will visit our family and take an Alaska cruise from August 12 to 25. Dawn and John will be visiting family in Washington state at the same time. Thi and Allen will be going to Vietnam and Thailand from August 20 and return September 9 (or maybe later).
That means there will be a “gone fishing” sign on our office door from August 20 to 25.
We’ll see you when we return!
Third Circuit disallows deduction for redemption of ESOP stock
The Third Circuit Court of Appeals affirmed a decision of a New Jersey Federal District Court that payments by a corporation in redemption of its stock held by an ESOP in order for the ESOP to pay retirement benefits is non-deductible.
The corporation, Conopco, claimed the payments should be deductible under Internal Revenue Code Section 404(k)(1) as an “applicalble dividend paid in cash with respect to applicable employer securities.”
The Third Circuit agreed with the District Court that Internal Revenue Code Section 404(k)(1), which says “no deduction otherwise allowable shall be allowed under this chapter for any amount paid or incurred by a corporation in connection with the reacquisition of its stock or of the stock of any related person.”
(Conopco, Inc., 2009-2 USTC 50,492, July 20, 2009.)
Million dollar compensation cap doesn’t apply to compensation under agreement made before IPO
The IRS privately ruled that compensation paid by a publicly held corporation according to an employment agreement made before the corporation was publicly held before the expiration of a reliance period as disclosed in its offering prospectus was not subject to the million dollar limit for compensation paid by a publicly-held corporation.
(Letter Ruling 200919020, 2/2/2009.)
Tune in for Financial Insider Weekly
Most of you should have been notified that the premiere show for Financial Insider Weekly was broadcast Wednesday, August 5 at 4:30 p.m. This is a series of interviews for which I will be the host on public access television station CreaTV.
The half-hour shows will be broadcast Wednesday afternoons at 4:30 p.m. Pacific Time. You can watch them on Comcast channel 15 in San Jose and Campbell, or as streaming video online at www.creatvsj.org.
On the show, I will be interviewing some of the best attorneys, accountants, business professionals and financial advisors in the Silicon Valley.
Here are the guests and topics for August 2009: (The interviews have already been recorded.)
- August 5 – Craig Martin, CFP of The Family Wealth Consulting Group, “Investing In Turbulent Times.”
- August 12 – Craig Martin, CFP of The Family Wealth Consulting Group, “Why Use A Fee-Only Financial Planner.”
- August 19 – William Mahan, Attorney, “The Mechanics Of Short Sales and Foreclosures.”
- August 26 – William Mahan, Attorney, “Tax Considerations For Short Sales and Foreclosures.”
We will be posting the shows online and will sell them on DVDs for a small charge. The web site for the show is www.financialinsiderweekly.com.
Let me know any ideas that you have for topics or guests. Guests will usually have to be located in or near the Silicon Valley in California.
Hope you watched or recorded the show. Please tell your friends about it!
IRS says it can seize non-transferable options
The IRS said in a Chief Counsel Advice that it can seize and sell employee stock options despite the fact the options are non- transferable.
For the situation at issue, the employee had vested incentive stock options and non-qualified stock options and had terminated employment with the issuing company. The IRS issued levies for taxes due against compensation due, including the unexercised stock options.
As is usually the case, the terms of the options provided they were non-transferable, except for transfers upon the death of the employee. Options usually have these conditions to meet requirements under the Internal Revenue Code.
According to the Chief Counsel, the restrictions for employee stock options are overridden by Internal Revenue Code Section 6334(c), which gives the Internal Revenue Service broad collection powers.
(IRS Letter Ruling 200926001, January 9, 2009.)
Employer deduction changes proposed for employee stock options
Senators Carl Levin, D-Mich. and John McCain, R-Arizona, have introduced legislation that would change how the employer’s tax deduction for employee stock options is determined called The Ending Excessive Corporate Deductions for Stock Options Act, (Sen. 1491.) Under their proposal, the deduction would be the same as the amount expensed on the corporate financial statements.
This proposal would eliminate the parity in the current system, where the amount and timing of the deduction for the employer is the same as for the income taxable to the employee. Senators Levin and McCain believe the current system results in excessive deductions to employers because they don’t correlate to the financial reporting amounts.
Since many stock options lapse unexercised because they are “underwater,” it’s hard to say what the net revenue effect would be from the proposed change.
Similar proposals have been made in the past and haven’t been enacted. If you want the current system to remain in place, tell your representatives in Congress.
California withholding and estimated tax will be messy
As part of the shell game to balance California’s state budget, there will be changes in withholding and estimated tax payments.
Effective for payments on or after November 1, 2009:
- Withholding on wages increases by 10%;
- Withholding on supplemental wages increases from 6% to 6.6%;
- Withholding on stock options and bonus payments increases from 9.3% to 10.23%.
For estimated tax payments of noncorporate taxpayers for 2010, 30% will be due for the first quarter, 40% will be due for the second quarter, 0% for the third quarter(!), and 30% for the fourth quarter.
Effective for payments on or after January 1, 2010, California will require that 7% backup withholding be made when a California taxpayer is subject to federal backup withholding. Backup withholding will apply for payments subject to California’s withholding at source statute, including rents, prizes, compensation for services and other fixed or determinable periodic income, but excluding interest and dividends and the release of loan funds by a financial institution in the normal course of business.
Businesses that have a local business license, have at least $100,000 of gross receipts from business operations, and do not collect sales taxes will also be required to register with the State Board of Equalization to report any use tax owed for purchases made during the preceding year. The initial use tax return will be due April 15, 2010.
(Spidell’s California Taxletter, August 1, 2009.)
Questions and Answers
Please send your questions to email@example.com. I will answer selected questions in this newsletter.
I purchased a number of ISO shares when I left my last company. It’s been about 1.5 – 2 years and they have since gone through an MBO and it turns out that all common shares are now worthless, leaving me with nothing.
I view this situation as a long-term loss (more than two years after the options were granted and more than one year after the exercise).
Please confirm that I can claim the loss on the income tax return for this year.
To claim the loss, you must establish that the shares were worthless and when they became worthless.
I suggest that you get a letter from the company or some other authoritative source confirming that the shares became worthless in 2009. With that written confirmation in hand, you can claim the loss on your 2009 Schedule D.
Remember you might have a different tax basis for the stock for regular and AMT reporting. If you can generate capital gains, this can help you recover some of your minimum tax credits.
Please send your questions to firstname.lastname@example.org. I will answer selected questions in this newsletter.
Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter.
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.
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.
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 author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)