Michael Gray, CPA’s Option Alert #76

An irregular alert for issues relating to employee stock options

January 8, 2010
© 2010 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 New Year!

The first decade of the second millennium is over. Most of us are glad to see it end.

We started with the “Y 2K” scare, which turned out to be a non- starter. We had the World Trade Center attack on September 11, 2001. We had two bubbles and stock market crashes, with the market gains of the decade erased. The worst recession since the Great Depression is ending with a “jobless recovery.” Yuck!

On the plus side, we have had two of our children married to great partners and three beautiful grandchildren.

Life goes on! I believe and hope better times are ahead.

It’s time to make new goals and a “timetable of success.”

Remember the old saying, “People don’t plan to fail; they fail to plan.”

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Tax preparation materials are on the way

We are mailing instructions to those of you who use the online Tax Notebook this week. If you use a paper organizer, you should have already received it. If we prepared your tax returns last year and you haven’t received instructions by January 15 or you would otherwise like to receive instructions, call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162.

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Make your tax preparation appointment now

If you would like to schedule an appointment for a tax preparation interview, also please call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162.

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Yes, we do prepare income tax returns!

With our free newsletters and the information we make available at no charge on the web, some people wonder how we make a living. We prepare income tax returns and provide tax and business consulting services. We are accepting selected new clients and are thrilled when our clients and friends refer their friends, associates and family members to us. To inquire about becoming a client of our firm, please call Dawn Siemer at 408-918-3162 or send an email to her at mgray@stockoptionadvisors.com. We must receive your tax information by March 1 to guarantee delivery by April 15.

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Final 2009 estimated tax payment is due January 15

The final estimated tax payment for calendar-year individuals, estates and trusts is due January 15. You might want to check with your tax advisor about reducing the payment if you had much lower capital gains in 2009 than in 2008, you are entitled to the increased federal refundable minimum tax credit, or your facts have otherwise changed.

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’Tis the season to exercise ISOs?

Since stock received from exercising an incentive stock option has to meet two holding period tests (more than two years after grant and more than one year after exercise) to avoid having the excess of the fair market value over the option price taxed as ordinary income, exercising early in the year can be advantageous when you decide to hold the stock after exercise. The reason is you have the alternative of selling the stock before the end of the year of exercise and possibly avoiding the alternative minimum tax if the value of the stock drops after exercise. I call this tax strategy the “escape hatch.”

Be careful about blackouts. I have had some individuals call me who wanted to use the escape hatch during December, only to discover they were prohibited from selling their shares because they were subject to an employee blackout. Sometimes blackouts can happen unexpectedly, like when an employer becomes a party to a lawsuit. There’s no magic solution in these cases – you could be stuck with a significant tax liability.

For many people, the exercise and immediate sale of the shares is the most comfortable alternative, even if the tax bill is higher.

Also remember the wash sale rules can spoil an “escape hatch” transaction. You can’t repurchase the shares or even receive an employee stock option or buy a put option during the period starting 30 days before the sale to 30 days after the sale.

Another advantage of an exercise early in the year is to be able to meet the holding period requirements and sell the shares before the tax is due on April 15. But check the estimated tax payment requirements to avoid penalties for late estimated tax payments. (The alternative minimum tax liability can also be payable as an estimated tax liability.)

The tax picture is changing for ISO exercises during 2010. The maximum tax rate for ordinary income is scheduled to increase from 35% in 2010 to 39.6% in 2011. The maximum tax rate for long-term capital gains is scheduled to increase from 15% in 2009 to 20% in 2010. The maximum AMT rate is scheduled to remain the same at 28%. The AMT exclusion is up in the air for both years.

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AMT exclusion unknown for 2010

With the debate over health care reform, Congress wasn’t able to address many important tax issues for 2010, including the AMT exclusion. Watch for legislation during 2010.

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New book released about managing employee stock options

John Olagues trades exchange-traded options. He has just released a new book Getting Started In Employee Stock Options through publisher John Wiley. You can buy it at Amazon.com through our affiliate link by clicking the title of the book.

Mr. Olagues has different insights for reducing the risk of holding employee stock options while getting more cash from them than you will hear from most tax advisors or financial planners. His ideas are well worth studying, and the investment for the book is peanuts.

If you have employee stock options, especially for a publicly- traded company, you really should have and read a copy of this book.

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IRS issues some relief for deferred compensation plans

The IRS has issued a Notice providing relief for correcting documentation errors relating to non-qualified deferred compensation plans for implementing the penalty provisions under Internal Revenue Code Section 409A.

The plan must have actually operated in conformity with the requirements of Section 409A in order to qualify, and documentation for stock rights such as non-qualified stock options don’t qualify for the relief.

My printout of the Notice is about 42 pages long, so I can’t explain them in detail. Various examples of impermissible and corrected language are given.

Corrections under the Notice must be made no later than December 31, 2010.

If you are responsible for administering a non-qualified deferred compensation plan, you should discuss this Notice with your tax advisors and attorneys. If you are an advisor or attorney assisting clients with these plans, you should study the Notice.

(IRS Notice 2010-6, January 6, 2010.)

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Bush tax cuts to expire after 2010

2010 will be an unusual year for tax planning because many tax rates will probably increase in 2011. As presently scheduled, the maximum personal income tax rate will increase to from 35% to 39.6% and the maximum rate for long-term capital gains will increase from 15% to 20%. Many taxpayers will choose to accelerate income to 2010, including selling securities to report long-term capital gains. Remember, the wash sale rules don’t apply to gains, so you can repurchase stock that you have sold at a gain and establish a new tax basis and holding period for the replacement stock.

The tax break for qualified dividends, subjecting them to the same maximum 15% income tax rate that applies to long-term capital gains, is also scheduled to expire, which could result in tax rates up to 39.6% applied to qualified dividends.

There are tax benefits to having an S corporation with no accumulated earnings and profits from years before the election was made. The S corporation can elect to have distributions apply to any accumulated earnings and profits before distributing the current S corporation income. If you have such a corporation and haven’t already made the election, consider doing so during 2010.

There are many more changes, including expired tax benefits, that are up in the air pending action by Congress.

Before taking action on any of these items, consult with a tax advisor for a “sanity check” relating to your personal situation.

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See our special reports for 2010 “hot topics”

We are including with this newsletter two reports about estate tax repeal and converting an IRA to a Roth. Be sure to look them over to see if they apply to you:

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Financial Insider Weekly is broadcast in more communities

KMVT, cable channel 15 in Cupertino, Mountain View and Los Altos has agreed to broadcast my weekly television show, Financial Insider Weekly. The shows will be broadcast at 4 p.m. Friday afternoons. Check it out and tell your friends!

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Financial Insider Weekly broadcast schedule for January and February

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 4:30 p.m., Pacific Time. You can watch it on Comcast channel 15 for those cities. The show is broadcast as streaming video at the same time at http://www.creatvsj.org.

Here are the scheduled interviews for January and February:

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”
February 3, Professor Patricia Cain, “Income tax problems of same sex couples”
February 10, Professor Patricia Cain, “Estate and gift tax problems of same sex couples”
February 17, David Beck, “Applying for financial aid for higher education”
February 24, David Beck, “Evaluating and appealing university offers and student loans”

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!

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Questions and Answers


If I exercise an ISO for private company stock with a stated fair market value of $565 and an option price of $65 and sell the stock during the year of exercise to a relative for $70, will I pay income taxes based on the fair market value or the sales price for the disqualified disposition?


According to Section 422(c)(2), reporting income for a disqualified disposition based on the selling price of the stock is only permitted if a loss (if sustained) would be allowed for the transaction. Under Section 267, losses for sales to certain related parties are disallowed, including siblings, ancestors and descendants.

Even if you make a sale to a “qualifying” relative or friend, the IRS might find the transaction to be part sale, part gift because of the sale being made substantially below the fair market value reported by the company.

Therefore, I don’t recommend such a sale to avoid the alternative minimum tax. A sale to a person with whom you have no personal relationship with no strings attached and some stated rationale for the discounted selling price, such as lack of marketability and financial hardship, is a possibility. Most private companies won’t permit sales of the shares under these circumstances.


I was employed in 2009 by a company with privately owned stock. I was downsized in the beginning of August 2009 and exercised my options in November 2009. I was then going to sell the shares to an outside investor during December 2009. The company was notified of this intent and exercised a right of first refusal. The company’s purchase will conclude on January 12, 2010.

I believe the options were non-qualified.

What are the reporting requirements for the company and what documents will they issue for 2009? Will withholding be required for the stock sale? Will I receive a 1099 for the stock sale for 2010?


You should be discussing these issues with your former employer.

The following items relate to non-qualified stock options.

Your employer should have withheld income taxes when you exercised them.

Your employer should include income from exercising the options on your 2009 Form W-2, and should issue a Confirmation of Exercise statement with the details of the transaction.

Some companies report the proceeds for the purchase of the stock during 2010 on Form 1099-MISC. (Form 1099-B is for stock brokerage companies.) I’m not sure if it’s required. Whether you receive the form or not, you should report the sale on your 2010 income tax return. Remember to add the income reported on Form W- 2 for the exercise of the option to the tax basis (cost) of the stock.

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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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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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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