Michael Gray, CPA’s Option Alert #79

An irregular alert for issues relating to employee stock options

April 7, 2010
© 2010 by Michael Gray, CPA
ISSN 1931-2768

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Only 8 days left in tax season! Time to think about extensions

There isn’t enough time left to give preparing tax returns the attention they deserve, but we can help a few more new clients with extensions and finish their returns later. To make an appointment, please call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Received an AMT credit refund? Thank Reform AMT!

When you receive a refund because of a refundable minimum tax credit, it’s easy to forget that you are receiving that refund because of the efforts of others to convince Congress that unused minimum tax credit from a decline in stock value is an injustice. On the west coast, the lead organization leading that lobbying effort over a ten-year period was Reform AMT.

There are still unpaid bills for that lobbying effort. Please consider making a non-deductible contribution to Reform AMT as an expression of your appreciation for your refund. You can make the donation online at www.ReformAMT.org.

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Extensions – and when you don’t have the money to pay the tax.

(This is a reprint from past newsletters.)

What do you do when you don’t have the money to pay the tax?

My first recommendation is to file your income tax returns, certified mail, by the initial filing date. One of the nastiest penalties in the IRS’s arsenal is for late filing – 5% per month to a maximum of 25%. Some people who owe money don’t file their returns because they are afraid. THIS IS A HUGE MISTAKE! The best approach is to be honest about your situation and work with the tax authorities to resolve it.

When you file an extension, any balance of tax due when the tax return is filed represents an exposure for the late filing penalty.

Please don’t misunderstand me. I regularly use extensions for my clients and myself as a workload “safety valve.” We often don’t have the information to complete a return by the due date. They just aren’t appropriate when there will be a significant balance due that won’t be paid by the original filing due date.

Remember the automatic extension of time to file for 2009 individual income tax returns is for six months to October 15, 2010.

Remember to state a good (high side) estimate of total tax liability for 2009 on line 4 of federal Form 4868 or the extension will be invalid. According to the Treasury regulations for the requirements to file a valid automatic extension request, “an application for extension must show the full amount properly estimated as tax for the taxable year.” (Reg. § 1.6081-4(a)(4).) The regulations relating to reasonable cause for failure to file a tax return state that if a taxpayer satisfies the requirement of showing the full amount estimated as tax, the taxpayer has a reasonable cause for failure to file during the extension period provided (1) the excess of the amount of tax shown on the return over the amount of tax paid by the original filing date (including the amount paid with the extension form) is no greater than 10 percent of the amount shown on the return (restated, 90% of the tax is paid by the due date), and (2) any balance due shown on the return is paid with the return. (Reg. § 301.6651-1(c)(3).)

(For California taxpayers, the extension is paperless so the amount of the tax need not be stated. You are still required to pay at least 90% of the tax by the original due date with Form FTB 3519 to avoid the late filing penalty.)

If you have filed an income tax return for 2008, you can process your federal extension electronically (using tax return preparation software or through a tax return preparer). If you make a tax payment using a credit card, you can extend your income tax return by calling 888-729-1040 or 800-272-9829 by April 15. (For California extension payments, the extension is 1555.) Better call early to beat the rush! Mailing a paper form is still acceptable and is the only way a person who didn’t file a 2008 income tax return can request an automatic extension.

You can also make a credit card payment online at www.pay1040.com or www.officialpayments.com. California also has a web payment option at www.ftb.ca.gov.

A taxpayer can still avoid the late filing penalty by demonstrating a “reasonable cause,” but this can be a hassle and the taxpayer is at the mercy of the subjective judgment of a representative of the tax authority.

Should you borrow using a margin account? In most cases, this is not a good choice because of the exposure to margin calls if the market declines.

Should you use an equity advance loan, secured by your principal residence? In some cases it might be to your advantage, if you can get a favorable interest rate. Remember that interest for an equity loan not used for a home improvement is only deductible on a loan amount up to $100,000. This interest is not deductible when computing the alternative minimum tax.

Remember that IRA accounts and even other retirement accounts can be temporary sources of funds. Distributions from IRAs that aren’t minimum required distributions can be rolled over to another IRA or returned to the same IRA within 60 days after a withdrawal. This exception only applies to one rollover per year. (You must wait more than one year after a rollover is completed before making another one.)1

Certain distributions from other qualified plans can also be rolled over within a 60-day period to an IRA or another qualified plan.2 Using IRAs or qualified plans as a temporary source of funds to pay taxes can be useful if the funds to complete the rollover will soon be available, such as when there is a lockout “window” that will soon be open. The cost of an error can be high, because if the rollover isn’t completed before 60 days have expired, the distribution may be subject to tax as ordinary income plus a 10% early distribution penalty.3

The IRS has a form for installment agreements, Form 9465. They would prefer that you submit the form with your income tax return. You can take up to five years to pay off your tax liability. An advantage of arranging an installment agreement is the penalty for late payment of tax is reduced from 1/2% per month to 1/4% per month. In addition to penalties, interest is charged for late tax payments. The interest rate is adjusted quarterly. Recently, the rate has been eight percent.

Another alternative is to make an Offer in Compromise, Form 656. With this procedure, the IRS actually can reduce your tax based on your ability to pay. You don’t have to wait until you have owed the tax a long time to use this procedure. I think it’s best to work with an attorney, CPA or enrolled agent when making an Offer in Compromise. If the amount is large, an attorney is probably the best choice. (This may be an exercise in futility. The IRS has recently been rejecting almost all offers. You are required to make a non-refundable deposit of 20% of the compromised tax in most circumstances. It’s sad, because taxpayers really need this relief.)

Although it may provide relief from your other creditors, bankruptcy doesn’t offer much help for recent debts for income taxes. When you make payments on your tax bill, be sure to specify to apply the payments to taxes due. Penalties and interest are dischargeable in bankruptcy, but income taxes aren’t.

It may be to your advantage to plan how to use regular tax or alternative minimum tax capital loss carryovers or minimum tax credit carryovers. You might need to generate capital gains, which can be difficult when you’re in financial distress.

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What to do when your state is holding refunds.

Some states, such as Hawaii, are holding refunds due to the current cash crunch. Consider making an arrangement to apply the overpayment to next year’s estimated tax and reduce your withholding at work or next year’s estimated tax payments.

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First individual estimated tax payment is due April 15.

(This is a reprint from past newsletters.)

Remember to review your estimated tax situation for 2010.

There is no estimated tax penalty provided the taxpayer pays at least 90% of the tax (including AMT) on the current year’s tax return through withholding and/or equal quarterly estimated tax payments.

For taxpayers who have no more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year’s income tax return, there is no penalty for underpayment of estimated tax provided at least the income tax on the previous year’s income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.4 For taxpayers who have more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year’s income tax return, there is no penalty for underpayment of estimated tax provided at least, for 2010, 110% of the income tax on the previous year’s income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.5

Remember California now requires 30% of the estimated tax liability to be paid for the first quarter of 2010, 40% for the second quarter, none for the third quarter and 30% for the fourth quarter.

Taxpayers who have uneven income and deductions may also compute their estimated tax on an “annualized” basis. You multiply the year to date income and deductions to arrive at amounts for a year, compute the tax for that amount, then pay federal amounts to cumulatively pay in 1/4, 1/2, 3/4 and 100% of those amounts. You should probably get help from a professional tax return preparer to do this. (California wants cumulative amounts of 30%, 70%, 70% and 100%.)

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Last chance to make an IRA or Roth contribution for 2009.

Remember the final due date for IRA and Roth contributions for 2009 is April 15, 2010. We don’t think making an election to have a tax overpayment deposited to an IRA or Roth account is a good idea for income tax returns filed during the last two weeks of tax season. It’s too easy for a refund to be delayed past the due date.

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Health Care Reform includes tax changes.

As you know, Congress has passed and President Obama has approved significant health care reform legislation. There are a number of tax provisions in the legislation that I don’t have time to discuss in detail.

  • One is an increase of the Medicare tax on high-income taxpayers, including a tax on investment income! The 3.8% tax won’t take effect until 2013. It applies to individuals with adjusted gross income of $200,000 for singles, $250,000 for married filing joint returns. A 0.8% additional Medicare payroll tax will also apply.
  • For 2010 through 2013, eligible employers may qualify for a sliding-scale tax credit of up to 35% of their contribution to employees’ health insurance premium. Eligible small employers have no more than 25 employees and average annual wages of less than $50,000. For 2014 and beyond, eligible employers who purchase coverage through an insurance exchange may qualify for a credit for two years of up to 50% of their contribution. Salary reduction contributions are not counted.
  • Cafeteria plan rules are relaxed to encourage more small employers to offer tax-free benefits to employees.
  • Beginning in 2018, a 40% nondeductible excise tax will be imposed on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of an inflation-adjusted $10,200 for individuals and inflation adjusted $27,500 for families. The tax will apply to the amount in excess of the thresholds.
  • Effective for tax years beginning after December 31, 2012, the threshold for the regular tax itemized medical deductions will be increased to the same as for the alternative minimum tax from 7.5% to 10%. The threshold increase will be postponed for individuals age 65 and older and their spouses until after 2016.
  • The exclusion for family health care benefits will apply to adult children under age 27. The deduction for health insurance for self-employed individuals will also apply to this coverage.
  • Starting in 2014, monthly penalties will apply to individuals not eligible for Medicaid, Medicare, other government-sponsored coverage or other exemptions who don’t have health insurance coverage.

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Jobs Act includes tax changes.

President Obama signed the Hiring Incentives to Restore Employment Act on March 18. The Act includes some important tax incentives.

  • The employer’s part of Social Security tax of 6.2% of an employee’s taxable wages up to $106,800 is waived for covered workers on the employer’s payroll after March 18, 2010 and before January 1, 2011. The covered employee must begin employment after February 3, 2010 and before January 1, 2011. The covered employee can’t be hired to replace another employee of the qualified employer, unless the other employee voluntarily quit or was terminated for cause. The covered employee may not be related to the employer. Household employers are ineligible for the credit. In order to qualify, the employees must certify they were unemployed during the 60 days before beginning work, or that they worked fewer than a total of 40 hours for another employer during the 60 day period. The IRS is developing a form for employers to use for the certification. Remember, Medicare tax still applies!
  • The increased $250,000 expense election limit, which had expired at the end of 2009, has been extended through December 31, 2010. The investment limitation up to $800,000 before the expense election is phased out has also been extended.

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Financial Insider Weekly broadcast schedule for April and May.

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 April and May:

April 14, Lori Greymont of Summit Solutions Team Corp., “Real estate investment strategies I”
April 21, Lori Greymont of Summit Solutions Team Corp, “Real estate investment strategies II”
April 28, James Quillinan, Esq. of Hopkins & Carley, “Tax planning and compliance issues of federal estate tax repeal for 2010”.(Note schedule change!)
May 5, James Quillinan, Esq. of Hopkins & Carley, “California real estate change of ownership rules in estate and business planning”
May 12, Don Pollard of Advanced Professionals, “What Federal Health Care Reform means for you”
May 19, Don Pollard of Advanced Professionals, “Medical insurance alternatives”
May 25, To be announced

Financial Insider Weekly is also broadcast as follows:

  • Sunday at 5 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California
  • Monday at 7:30 p.m. on Comcast channel 15 in Saratoga
  • Thursday at 5:30 p.m. on Comcast channel 27 in Santa Cruz County and Charter Communications channel 73 in Capitola and Watsonville
  • Thursday at 7 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County
  • Thursday at 10 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California
  • Friday at 4 p.m. on cable channel 15 in Cupertino, Los Altos and Mountain View
  • Friday at 4:30 p.m. on Comcast channel 15 in Los Gatos

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


I recently left a start-up and have 60 days to exercise my non-qualified stock options. I understand that when purchasing I have no capital gains and do not need to pay taxes. But, if the company folds, then I have paid for stock that is worthless. Is the loss tax deductible?

For example, if I buy 10,000 shares at 10¢ per share, the shares will cost $1,000. Would a loss be tax deductible?


The loss would be a capital loss deductible on Schedule D. Deductions for capital losses are limited to capital gains plus $3,000. See the instructions for Form 1040, Schedule D.

Incidentally, your letter assumes the fair market value of the stock at exercise is less than or equal to the option price. Otherewise, there would be taxable income at exercise.


I’m buying my first house.

I have $20,000 in an employee stock purchase plan. I bought the shares on 12/15/2008, 6/15/2009 and 12/15/2009.

I want to sell the stock and use it as a down payment on the house.

Do I still have to pay capital gains tax for the sale of the stock?


Yes. There is no exclusion from income for the sale of ESPP shares when the proceeds are used to buy a residence.

Also, you will have disqualifying dispositions for the sales of your ESPP shares before meeting the holding period requirements.

You might want to consult with a tax advisor about what the tax results will be from the disposition, or get a copy of my book, Secrets of Tax Planning For Employee Stock Options, 2009 Edition at http://www.siliconvalleypublishingcompany.com/products/secrets-of-tax-planning-for-employee-stock-options-2014-edition Check out this FAQ http://www.stockoptionadvisors.com/esofaq/hold.


I exercised and held ISOs last year and the tax preference for the excess of the fair market value of the stock over the option price was about $30,0000. From what I understand, since the preference is under the AMT exemption of $45,000 for a single tax filer, then I won’t have an AMT. Is that right?

Also, I thought some of the information for the exercise should be reported on my W-2. Is that right?


No, I’m afraid you are mistaken on both counts.

Your additional AMT income is added to your regular income on Form 6251. I suggest that you get a copy of the form and instructions at www.irs.gov.

The information isn’t reported on Form W-2, but your employer is supposed to provide you with a statement of information for you to report on your income tax return.


I retired last year and my NQSO had an expiration date of January 31, 2009. I tried to exercise them, but they were “underwater.”

Can I take a capital loss on Schedule D for the excess of the grant price over the fair market value at expiration?


No. You had no tax basis or cost for the options because you didn’t have taxable income when your received them.

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.

1 Internal Revenue Code § 408(c)(3) RETURN
2 Internal Revenue Code § 402(c) RETURN
3 Internal Revenue Code § 72(t) RETURN
4 Internal Revenue Code § 6654(d)(1) RETURN
5 Internal Revenue Code § 6654(d)(1)(C) RETURN

(Michael Gray is the author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)

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