Michael Gray, CPA’s Option Alert #75
An irregular alert for issues relating to employee stock options
December 7, 2009
© 2009 by Michael Gray, CPA
(If you find this information valuable, please pass it on to a colleague!)
Table of Contents
- Happy Holidays!
- Now is the time for year-end planning
- Exercise ISOs during 2009? Consider the “escape hatch”!
- Remember Refundable AMT credit
- Should you “harvest losses”?
- Remember to make your property tax payment
- Taxpayer stuck with stock exchange value for stock grant
- Final regulations issued for ESPPs
- Final regulations issued for information reporting
- December “Half Price Sale” for our books
- Financial Insider Weekly broadcast schedule
- Possible estate tax repeal a problem
- Should you make a state income tax payment now?
- Questions and Answers
- Follow me on Twitter!
- Do you know about our other newsletters?
- IRS Circular 230 Disclosure
- Consult with a tax advisor
- Subscribe to Michael Gray, CPA’s Option Alert
2009 is ending with hopeful news for a better year ahead. We hope you enjoy a Happy Holiday season.
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.
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.
If you exercised ISOs during 2009, should you use the “escape hatch”?
Remember if you exercised ISOs during 2009 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, 2009. The fair market value of the shares on March 1, 2009 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, 2009 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, 2009, she would still have a disqualifying disposition of the ISO shares, but she would have $50,000 of 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.
Remember Refundable AMT credit
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 and created additional refundable credits for interest and penalties paid in prior years relating to an alternative minimum tax for the exercise of an incentive stock option.
Also, since many taxpayers will qualify to receive the refundable minimum tax credit for 2009 who couldn’t receive it before, they can reduce or eliminate their estimated tax payments for 2009.
See the article at our web site http://www.stockoptionadvisors.com/refund
Should you “harvest losses”? Watch the wash sale rules!
Do you still have unrealized losses? You may choose to sell investments before the end of the year so you can deduct the losses. This is euphemistically called “harvesting losses.” (Make the best of a bad situation.)
Remember, the deduction for capital losses for a tax year is limited to $3,000 plus capital gains. (For corporations, the deduction is limited to capital gains only. Any excess capital losses are carried forward indefinitely. (C corporations may carry capital losses back three years and forward five years.)
If you don’t have capital gains to apply the losses to, you won’t be receiving much of a current tax benefit from harvesting losses.
Also remember that losses aren’t deductible when identical securities or options to buy identical securities are acquired during the period 30 days before to 30 days after the sale. This is called a wash sale. Instead of identical securities, you can buy a similar security, including a different mutual fund in the same asset class. Again, find out whether a capital gain dividend is pending for a mutual fund, how much the dividend might be, and what the date of record is to identify who the dividends will be paid to. See your investment advisor for advice about your portfolio management.
Remember to make your property tax payment
The due date of the first installment of California real estate tax is December 10. There is a nasty penalty for making a late payment, so remember to make your payment on time.
Taxpayer stuck with stock exchange value for stock grant
Olafur Gudmundsson received a grant of stock from his employer, Aurora Foods, Inc., on July 1, 1999. The grant was approved in a board of directors action on July 1, 1998. Mr. Gudmundsson was a corporate insider subject to the restrictions of SEC Rule 16(b).
After the stock was issued, some fraudulent financial reporting was discovered and most of the corporate management was terminated. Mr. Gudmundsson was not involved in the fraud and unaware of it.
The stock market value of the stock dropped dramatically after the fraud was disclosed and financial statements were restated.
After initially reporting compensation based on the stock market value of the stock on the date the shares were received, Gudmundsson filed a claim for refund based on the allegations that the stock was subject to restrictions under SEC Rule 16(b), so the value should be used as of December 31, 1999 when those restrictions lapsed and that the value of the stock should be reduced because the financial statement fraud resulted in a value that wasn’t the true fair market value.
A New York District Court found the waiting period under Rule 16(b) had actually lapsed on December 31, 1998, because the board of directors action had created a derivative security for a right to receive the stock in the future.
The court also found that since the stock was transferable or subject to restrictions that would otherwise lapse at a later date, the stock market value on the date the stock was issued should be used.
(Gudmundsson v. United States, W.D. N.Y., 2009-2 U.S.T.C. 50,722, (October 26, 2009.))
Final regulations issued for ESPPs
The IRS has issued final regulations for Employee Stock Purchase Plans (ESPPs). Corporations that offer an ESPP to their employees should review the updated regulations. Since the regulations principally relate to employers and the rules haven’t changed substantially, I’m not going to discuss details here.
Final regulations issued for information reporting for ISO and ESPP exercises
The IRS has issued final regulations for information reporting by employers relating to the exercise of an incentive stock option (ISO) or employee stock purchase plan (ESPP). The regulations implement rules enacted as part of the Tax Relief and Health Care Act of 2006.
Information reporting to the IRS was supposed to apply to exercises after 2006, but the IRS previously waived the requirement for 2007 and 2008. Now the requirement has also been waived for 2009. Employers are still required to provide the information to employees so they have it to prepare their income tax returns.
The employee statement should be provided by January 31 of the calendar year following the year of exercise.
The IRS plans to issue Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) and Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c) to be used to satisfy the employer information reporting requirements.
For ESPPs, the final regulations provide that a transfer of legal title to a recognized broker or financial institution immediately following an exercise (a “street account”) is treated as the first transfer of legal title for the purpose of filing.
For ESPPs, issuance of a stock certificate directly to an employee or registration of the shares in the employee’s name in its record book is not considered the first transfer of legal title of the stock acquired by the employee. The employer’s reporting requirement would be initiated by the first transfer of the legal title of the stock acquired by the employee, such as when the employee sells the stock or transfers it to a brokerage account. The exercise date and the date of initial transfer might be different.
In response to comments received, the final regulations require employers to disclose the exercise price per share determined as if the option were exercised on the date of grant (subscription date), so that employees can determine the ordinary income to be reported for a qualified disposition when the ESPP option price is determined based on the fair market value on the exercise date.
December “Half Price Sale” for our books on employee stock options
As a holiday season promotion, we are offering our books, Secrets of Tax Planning For Employee Stock Options, 2009 Edition and Executive Tax Planning for Employee Stock Options, 2008 Edition for half the regular price, which is what you would pay for them at Amazon.com.
Financial Insider Weekly broadcast schedule for December and January
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 December and January:
- December 9, Phil Price, EA, “Retirement plans for closely held businesses”
- December 16, Dick Blakely, “Benefits of a family office”
- December 23, Tom Oviatt, “Home mortgage developments”
- December 30, attorney Bernard Vogel, III, “Choices of forms for conducting closely-held businesses”
- January 6, attorney David Kirsch, “Preparing for an IRS audit”
- January 13, attorney David Kirsch, “When you owe taxes to the IRS”
- January 20, attorney Bill Mahan, “Why you need a Will”
- January 27, attorney Bill Mahan, “Estate and financial issues relating to your title to property”
Past episodes are available at https://www.youtube.com/user/financialinsiderweek.
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!
Possible estate tax repeal a problem
Under the Bush tax cuts, the federal estate tax is scheduled to be repealed for one year in 2010. If this happens, many estate plans that are designed around the estate tax rules won’t work. It will create a big mess of delays for estates and trusts of decedents who die during 2010 until the situation is stabilized by an extension of the tax by Congress. Legislation has been introduced and has passed in the House of Representatives to extend the estate tax for 2010 or make it permanent, but it might not pass in the Senate before the end of 2009 because of debates on health care reform legislation.
Consider consulting with your attorney for a contingency plan.
Should you make a state income tax payment before the year end?
Usually, you get the best tax result by matching deductions like state income taxes with the related income. Since itemized deductions for taxes aren’t allowed when computing the alternative minimum tax, you need to actually “crunch” your numbers to find out if this will really be an advantage for you.
Questions and Answers
I received a stock grant with a “clawback” vesting structure. If I make a Section 83(b) election, what will be run through payroll?
A Section 83(b) election is your election to disregard the “clawback” vesting, and treat the stock “as if” is was fully vested when received. Therefore, the entire grant would be currently taxable based on the fair market value on the grant date and subject to the related payroll taxes as of the grant date.
The election has to be made within 30 days of the grant date.
If you can’t afford to pay the taxes and making the election would put you in financial distress, you probably shouldn’t make the election.
With respect to the prior year exception for California estimated tax purposes, does the 110% prior-year exception still apply if you expect your 2009 AGI to exceed $1 million?
No. It stinks, doesn’t it?
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.
Follow me on Twitter!
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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.
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.)