Michael Gray, CPA’s Option Alert #77

An irregular alert for issues relating to employee stock options

February 5, 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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Remember Valentine’s Day is February 14!

My daughter and her husband, Holly and Dan Baker, tell me their restaurant, Marché aux Fleurs, is fully booked for Valentine’s Day. Hope you’ve made your reservation for your favorite restaurant. Janet and I will be babysitting two of our favorite “Valentines,” our grandsons Panch and Clive Baker, while their parents are working at their restaurant.

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Tax season is here! Make your appointment now!

There are only about two and one-half months left before the tax return due date. Time to get started now!

If we prepared your income tax returns last year, you should have already received instructions in the mail. If you haven’t, please call Dawn Siemer at 408-918-3162.

To have us prepare your income tax returns, start with the online Tax Notebook organizer. Call Dawn Siemer at 408-918-3162 for instructions to get started. We also have a paper organizer, if you prefer. We still need your documents (W-2s, 1099s, receipts for donations) to prepare your income tax returns.

We can prepare most income tax returns using information provided online and by mail. If you wish a personal meeting, please call Dawn Siemer at 408-918-3162 to schedule an appointment. Our calendar is filling up fast!

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NQOs didn’t qualify for small business stock exclusion

Sivatharan Natkunanathan’s employer corporation was acquired by Intel and his non-qualified stock options (NQOs) were converted to Intel NQOs. He exercised the NQOs and sold the stock on the same day.

Mr. Natkunanathan claimed 50% of the income from exercising the NQOs should be excluded from taxable income as income from qualified small business stock.

The Tax Court ruled against Mr. Natkunanathan. The Court said it didn’t think the NQOs should be treated as stock for this purpose. Even if it did, Mr. Natkunanathan didn’t provide any documentation that the options would have met the tests. He did not hold the actual stock for the required five-year holding period to qualify for the exclusion.

Since Mr. Natkunanathan was representing himself in this case, his lack of tax expertise was apparent to the Court.

(Sivatharan Natkunanathan v. Commisioner, T.C. Memo. 2010-15 (February 1, 2010.))

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Change in method for measuring stock-based compensation for cost sharing arrangement only allowed prospectively

A foreign corporate taxpayer applied to make a late election for its method of accounting for employee stock options and stock grants under its cost-sharing arrangement. It had missed election dates for an automatic change. Alternatively, it applied for a prospective change (to apply the method on future income tax returns).

The change was to conform with guidelines adopted by the IRS after the taxpayer had adopted its accounting method.

The IRS ruled it could only grant the change prospectively.

(IRS Letter Ruling 200953001 (September 30, 2009.)

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Congressional Research Service Issues Report On Employee Stock Options

The Congressional Research Service has issued an updated report on Employee Stock Options.

The report provides a summary to members of Congress about the history and developments relating to employee stock options and so can be a useful resource for those who study them.

An item highlighted in the report is the “book – tax gap” for financial accounting expense relating to employee stock options when granted compared to the tax deduction when the option is exercised. This is a targeted item for members of Congress seeking revenue increases. They believe this is an abuse. Never mind there is parity for the deduction claimed by the employer and the income reported by the employee. The tax rules for the deduction are much older than the rules for financial reporting.

So far, representatives in Congress have been unsuccessful in passing this “conformity” legislation, including S. 1491, the Ending Excessive Corporate Deductions for Stock Options Act, introduced by Senator Carl Levin. (Senator John McCain also favors this legislation.)

Since passing the legislation would provide a substantial disincentive for granting options, employees who favor them should tell their representatives in Congress they oppose this change.

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Financial Insider Weekly broadcast schedule for February and March.

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 www.creatvsj.org.

Here are the scheduled interviews for February and March:

February 10, Professor Patricia Cain, “Estate and gift tax problems of same sex couples”
February 17, David Beck, CFP, “Applying for financial aid for higher education”
February 24, David Beck, CFP “Using tax benefits and student loans to pay college costs”
March 3, attorney Ray Sheffield, “Estate planning for retirement benefits”
March 10, John Herzog of Valley Community Bank, “Small business financing”
March 17, Tom Anderson of Pensco, “Real estate investments in your IRA or Roth account”
March 24, Tom Anderson of Pensco, “Alternative investments in your IRA or Roth account”

Financial Insider Weekly is also broadcast Friday at 4 p.m. on cable channel 15 in Cupertino, Los Altos and Mountain View. Starting this week, it will also be broadcast Thursdays at 7 p.m. on cable channel 26 and AT&T U-verse channel 99 in Marin County.

Past episodes of Financial Insider Weekly are posted on YouTube. One way to watch them is to go to our web site, www.financialinsiderweekly.com, and click on “Past Episodes.”

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

Question

My fiancé was given 5,000 stock options by her employer. She resigned and was immediately asked to leave. Her stock option agreement stated that options must be exercised within 30 days of termination of employment. She sent her exercise notice on the 31st day after termination (via fax).

The company did not respond. Is there any grace period? I saw the Internal Revenue Code states 90 days after termination (for incentive stock options). Any grounds for an argument?

Answer

She might want to consult with an attorney, but I’m not very optimistic. The Internal Revenue Code gives parameters within which a plan can be written, but the plan can state a shorter period to exercise than the Code and will “trump” the Code provision. The fax should “date stamp” the notice as late.

Question

I am employed by a pre-IPO company and was awarded X incentive stock options with a 4-year vesting plan from 2006 to 2010. I have been exercising my vested incentive stock options regularly. Now, all of my ISO have vested and been exercised.

I heard that after each exercise I should have submitted a Section 83(b) election within 30 days to get my capital gains clock ticking. I paid the AMT tax for 2008 and 2009, and will for 2010. I did not submit the AMT form for 2007 because I didn’t owe the tax.

Should I have sent a Section 83(b) election to the IRS within 30 days after exercise?

Is there a problem since no AMT form was filed for 2007?

Answer

You are okay.

No Section 83(b) election was necessary because the ISOs that you exercised were VESTED!

The AMT form is not required to be submitted, even when you exercise an ISO, when there is no AMT due and no AMT credit carryover.

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, Facebook or LinkedIn!

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.

I’m also on Facebook and Linked In. You can also follow me on other social media sites, bit.ly/cVALrY and www.linkedin.com/in/michaelgraycpa.

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Check out my blog.

I have also started a blog at www.michaelgraycpa.com. Check it out!

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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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