Michael Gray, CPA’s Option Alert #73

An irregular alert for issues relating to employee stock options

October 12, 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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Final extended due date for 2008 individual returns

Remember the final extended due date for 2008 individual income tax returns is October 15, 2009. Call Dawn Siemer on Mondays, Wednesdays or Fridays at 408-918-3162 to make an appointment if you need help.

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It’s time for year-end tax planning

Since the year-end will soon be here and holidays and vacations are limiting our availability, now is the time to reserve your year-end planning appointment time. Most of us believe tax increases are ahead, and that the estate tax will be reinstated for 2010. Now may be the time to take steps to avoid increased tax bills later. Call Dawn Siemer on Mondays, Wednesdays or Fridays at 408-918-3162 to make an appointment.

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Court of Claims disallows refund based on fraudulent value of stock

In a summary judgment that can’t be cited as a precedent, the Federal Court of Claims disallowed a claim for refund based on the assertion that the value used to determine income was fraudulent.

Robert Gourley was employed as a scientist by WorldCom, Inc. On January 28, 2000, Gourley exercised nonqualified stock options for 90,300 shares of WorldCom received as a grant relating to his employment. He continued to hold the shares after exercising the option.

As a result of exercising the option, Gourley paid $1,922,344 for the exercise price of the option plus taxes due for the exercise. He borrowed about $2 million from the Bank of Oklahoma to pay these costs.

Starting March 1, 2000 and ending January 30, 2001, Gourley sold the shares.

WorldCom issued a Form W-2 to Gourley for 2000 showing total income of $2,690,414.97.

On June 25, 2002, WorldCom announced a major restatement of its financial statements. WorldCom had been incurring losses, not profits as reported, and it had concealed the losses through fraudulent accounting. 90% of the market value of WorldCom shares was erased.

On October 13, 2004, Gourley filed a claim for refund for income taxes, Medicare taxes, penalties and interest.

The Court cited Horwith v. Commissioner (71 T.C. 932, 938-29 (1979)) in finding that, for publicly traded stock, information that is later revealed that would result in a lower value is disregarded. The fair market value based on market trading on the date of exercise is controlling when computing taxable income.

(Gourley v. U.S., U.S. Court of Federal Claims, 2009-2 U.S.T.C. 50,611, (Sept. 4, 2009).)

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Financial Insider Weekly broadcast schedule for October and November

Financial Insider Weekly is broadcast on Wednesdays at 4:30 p.m., Pacific Time. You can watch it on Comcast channel 15 if you live in San Jose or Campbell, California. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for the rest of October and November:

October 14, attorney Jann Besson, “Qualifying for MediCal coverage for long-term healthcare”
October 21, Peggy Martin, CLU, “Long-term healthcare insurance”
October 28, Craig Martin, CFP, “How to outlive your retirement savings”
November 4, Steve Reiss, CPA, “The role of the business valuation specialist”
November 11, attorney Naomi Comfort, “Handling retirement accounts after a death”
November 18, Kathleen Wright, American Red Cross, “Financial preparation for a disaster”
November 25, attorney John Hopkins, “Legacy planning” (Benefits of charitable giving)

Past episodes of Financial Insider Weekly are posted at YouTube.

Past episodes are available at https://www.youtube.com/user/financialinsiderweek.

Eventually, we will offer DVDs of the interviews for sale.

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 can watch or record the show. Please tell your friends about it!

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Follow me on Twitter!

If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.

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Foreign bank account and foreign trust reports due October 15, 2009

An IRS amnesty program for reports of offshore accounts or trusts was supposed to end on September 23. The IRS has announced the due date is extended “for the last time” to October 15, 2009. (The due date for Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts is June 30 of the year following the year the report is for.)

As I’ve explained before, the IRS says these reports are required even when there is no tax avoidance resulting from the arrangement. For example, Mexican trust arrangements are required to hold Mexican beachfront property. Many commenters believe these arrangements are subject to reporting requirements.

The penalties are severe for failure to file, based on the fair market value of assets held by the trust. If you are wondering if this requirement applies to you, seek legal counsel.


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Governor vetoes California tax conformity

Governor Scwartzenegger has vetoed legislation that would have conformed many of California’s tax laws with the Federal tax laws. California has generally not adopted federal tax provisions enacted after December 31, 2004. Not conforming will result in many more errors on California income tax returns and confusion when planning for California transactions, especially for tax practitioners located outside California who don’t keep up with the differences between federal and California laws.

The Governor said he vetoed the legislation because it would impose penalties on taxpayers who filed refund claims without a reasonable basis.

(Spidell Publishing flash mail, 10-12-09.)

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Commission recommends California tax changes

Since California faces problems balancing its budget year after year, partly because of inconsistent revenue from its tax system, a commission was formed to make recommendations for changes to the system. The Commission on the 21st Century Economy released its report on September 29.

These are only recommendations that will be debated in California’s state legislature. Governor Schwartzenegger says he supports the recommendations.

The commission recommended:

  • Reduce the personal income tax. Under the proposal, there would only be two tax brackets: 2.75% for taxable income up to $56,000 for joint filers ($28,000 for single) and 6.5% for taxable income over those thresholds.
  • Eliminate the corporate franchise tax and $800 minimum tax.
  • Eliminate the 5% state sales tax, except for gasoline and diesel fuels, over a five-year period.
  • Establish a business net receipts tax of up to 4%. Small businesses with gross receipts less than $500,000 would be exempt from the tax.
  • Create an independent tax dispute forum. At this time, the initial place for hearing tax disputes is the State Board of Equalization, which administers the tax laws. There is obviously a conflict of interest in this forum.

These proposals represent a significant shift for state revenues, so there will be heated arguments on both sides about whether they should be adopted. They could go nowhere.

Eventually, California will have to “face the music” and solve its budget problems.

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Questions and Answers


If I exercise options by using old and cold shares under Internal Revenue Code Section 1036 (a swap), do I recognize tax preference on only the new shares I receive instead of all the option shares? If not, which shares have the additional AMT basis?


An equal number of shares to the number of shares surrendered keep the same tax basis and holding period. For regular tax purposes, any additional shares received that were paid for using the previously exercised shares have a tax basis of zero and the holding period starting on the date of exercise. If shares are sold before the holding period requirements are met, the shares for which ordinary income would be recognized are considered sold first. (Treasury Regulations § 1.422-5(b)(2).)

For alternative minimum tax reporting, the rules are similar to those for non-qualified options. An equal number of shares received to the number surrendered will receive the tax basis and holding period of the previously held shares. The fair market value of any additional shares received that were paid for using the previously held shares is reported as an AMT adjustment for exercise of the incentive stock options. The ordinary income reported for AMT will equal the excess of the fair market value over the option price of all of the ISOs that were exercised. (Internal Revenue Code § 56(b)(3), Revenue Ruling 80-244.)

Please send your questions to mgray@stockoptionadvisors.com. 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.

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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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