Michael Gray, CPA’s Option Alert #88

An irregular alert for issues relating to employee stock options

January 14, 2011
© 2011 by Michael Gray, CPA
ISSN 1931-2768

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Happy New Year!

2011 is here! Congress has given us a little breathing room by extending the Bush tax cuts. (See below.)

It’s time to make resolutions and take tax action for a better year ahead.

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Tax preparation materials will soon be on the way

We are mailing instructions to our clients this week. If we prepared your tax returns last year and you haven’t received instructions by January 20 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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Final 2010 estimated tax payment is due January 18

Remember the final estimated tax payment for calendar-year individuals, estates and trusts is due January 18. You might want to check with your tax advisor about reducing the payment if you had much lower capital gains in 2010 than in 2009, you are entitled to the increased federal refundable minimum tax credit, or your facts have otherwise changed.

Remember that California now has a strange estimated tax deposit schedule for 2010. There was no payment due on September 15, but 30% of the estimated tax for 2010 is due on January 18, 2011.

In addition, if any California estimated tax deposit is $20,000 or more, the payments must be made electronically. Once a payment is made electronically, the taxpayer must continue to make future payments electronically. The payments are made at the Franchise Tax Board’s web site, www.ftb.ca.gov.

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Information returns required for ISO and ESPP exercises

2010 is the first year for which information returns are required to be submitted to the IRS by employers about exercises of incentive stock options (ISOs) and for employee stock purchase plans (ESPPs). The information returns are Forms 3921 and 3922. The transmittal for the forms is Form 1096. The forms should be given to employees by January 31 and sent to the IRS. The forms should be mailed to the IRS by February 28, 2011 or efiled by March 31, 2011.

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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 exc ess 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” transation. 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 requirements to avoid penalties for late estimated tax payments. (The alternative minimum tax liability can also be payable as an estimated tax liability.)

As I discuss below, option holders have received a two year “reprieve” from higher tax rates from Congress. The maximum regular federal income tax rate for 2011 and 2012 remains 15%, until we face another expiration of the Bush tax cuts after 2012. The AMT exemption for 2011 will be $48,450 for individual taxpayers, $74,450 for married taxpayers filing joint returns and $37,225 for married taxpayers filing a separate return.

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IRS extends document compliance requirements for Deferred Compensation plans under Internal Revenue Code Section 409A.

The IRS has issued a notice modifying provisions of Notice 2008- 113, Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with § 409A in Operation and Notice 2010-6, Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with § 409A(a). If you are involved with compliance for these plans (including as they apply to nonqualified stock options), you should study this notice.

(Notice 2010-80, November 30, 2010.)

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For tax return preparers – do you have “use” consents from your clients?

Many tax return preparers are in the process of getting engagement letters for their annual tax return preparation engagements. If they offer services beyond tax return preparation to their clients, including tax planning, they should also be getting written client “use” consents. I have posted a recent presentation that I made, dressed as Patrick Henry(!) on the IRS Disclosure and Use Rules at www.taxtrimmers.com/threat.shtml, including YouTube video, an mp3 recording, handout materials, and a link to a Commerce Clearing House site about the issue. Check it out! Tweet it!

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California’s tax increases expire after 2010.

The .25% personal income tax rate increase for 2009 and 2010 has expired. The maximum California individual income tax rate is again 9.3%. The payroll tax withholding tables have been adjusted for the decrease. The 10% withholding increase for budget purposes continues in effect for 2011.

The California sales and use tax rates are scheduled to decrease by 1% on July 1, 2011.

Governor Brown is expected to introduce a ballot proposition to increase tax rates and avoid some draconian spending cuts for California.

(Spidell’s California Taxletter, December 1, 2010.)

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Bush Tax Cuts Extended.

Congress has passed and President Obama signed on December 16, 2010 the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The legislation extends the Bush income tax cuts for 2011 and 2012 for all taxpayers. That means the 35% maximum federal income tax rate for ordinary income and the 15% maximum rate for long-term capital gains remain in effect for 2011 and 2012.

Here are a few more highlights:

A tax cut that will broadly apply is the reduction of the employee’s social security tax rate from 6.2% to 4.2% for 2011. A similar tax cut applies to the self-employment tax for self- employed taxpayers. Since the maximum social security wages for 2011 is $106,800, the maximum tax savings will be $2,136. All taxpayers who receive wages will see this tax benefit on their first paycheck received for 2011.

Education benefits of the American Opportunity Tax Credit (available for married couples with modified AGI up to $160,000), the annual exclusion for up to $5,250 qualified education expenses paid on behalf of an employee, the $2,500 above-the-line deduction for student loan interest, and the $2,000 limit for contributions to a Coverdell Education Savings account have all been extended two years for 2011 and 2012.

The alternative minimum tax exemption (finally) was increased to $47,450 for individual taxpayers, $72,450 for married tax payers filing joint returns and $36,225 for married taxpayers filing separate returns for 2010. The exemption for 2011 will be $48,450 for individual taxpayers, $74,450 for married taxpayers filing joint returns and $37,225 for married taxpayers filing a separate return.

Individual taxpayers will be able to reduce both regular and alternative minimum tax liability by non-refundable personal credits, including the credit for nonbusiness energy property, for 2010 and 2011.

The tax credits for qualified energy efficiency improvements have been extended for 2011 only, but they have been scaled back. The credits were 30% to a maximum of $1,500 for 2010. For 2011, lower percentages and ceilings will apply. Otherwise eligible expenses will be reduced for amounts previously expensed. It will be hard for taxpayers to get many tax benefits from these expenditures for 2011.

The exclusion for up to $100,000 of amounts distributed from an IRA owned by a taxpayer who is over age 70 1/2 that are directly paid to a charity is extended for 2010 and 2011. The amount distributed is considered distributed to the taxpayer for the purposes of determining whether the requirement for making a minimum required distribution has been met.

Executors for decedents who died during 2010 will have a choice of estate tax repeal for 2010 with carryover basis or having the estate tax in effect with a $5 million exemption equivalent, a 35% federal estate tax rate and “fresh start” (stepped up) basis. The due date for estate tax returns for a decedent who died during 2010, the due date for paying estate tax and the date for making a qualified disclaimer are extended to September 16, 2011.

The federal estate tax and the federal gift tax are “re-unified” for 2011 and 2012, with a $5,000,000 exemption equivalent and a 35% tax rate, with “fresh start” basis. An unused exemption with respect to a deceased spouse who died during 2011 and 2012 will be “portable” and added to the exemption for the surviving spouse. (The unused exemption available will be from the last living spouse.) These estate tax provisions are a band-aid that will continue to be hard to work with for long-term estate planning.

The generation-skipping tax has a $5 million exemption equivalent for 2010 with a ZERO tax rate. It is restored for 2011 and 2012 with a 35% tax rate and a $5 million exemption equivalent.

Bonus depreciation is extended and expanded. (Remember bonus depreciation only applies to new property.) The first-year bonus depreciation allowance is 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012 (January 1, 2013 for longer-lived and transportation property like aircraft.) The allowance will be 50% for property placed in service after December 31, 2011 and before January 1, 2013 (after December 31, 2012 and before January 1, 2014 for longer-lived and transportation property). This provision is better than the expense election because there is no phase-out for large amounts of depreciable property acquired.

For taxable years beginning in 2012, the maximum amount a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced by the cost amount for qualifying property placed in service during the taxable year over $500,000. The eligibility of off- the-shelf software for the expense election is extended through 2012.

For more details, see your tax advisor.

Congress gave American taxpayers a nice Christmas present. We’ll see whether we will be in the same pickle in two years.

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IRS issues guidance for “in plan” Roth conversions.

The IRS has issued guidance relating to in-plan Roth conversions inside company 401(k) and 403(b) plans. These conversions are permitted after September 27, 2010 under the Small Business Jobs Act of 2010. For 401(k) plans, a conversion will be permitted if the plan is amended to permit it by the later of the end of the plan year in which the amendment is effective or December 31, 2011. An important point to know is, unlike IRA to Roth conversions, a 401(k) to Roth 401(k) conversion can’t be reversed after the end of the plan year. (Be sure you’re right before going ahead.) (Notice 2010-84.)

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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 7:00 p.m., Pacific Time. You can watch it on Comcast channel 15 for San Jose and Campbell. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for the rest of January and February:

January 19, Kathleen Wright, Attorney, American Red Cross, “Preparing Your Finances For A Disaster”
January 26, Naomi Comfort, Attorney, Hawks & Comfort, LLP, “Health Care Reform Update”
February 2, Craig Martin, CFP(r), The Family Wealth Consulting Group, “How to stretch your investment dollars during retirement”
February 9, Peggy Marting, ChFC, the Family Wealth Consulting Group, “Long-term care insurance”
February 16, Dean Fabro, Bank Of The West, “Small Business Financing”
February 23, Janis Carney, Attorney, Carney, Sugai & Sudweeks, LLP, “Veteran’s Administration Pension Benefits for Long-Term Care”

Financial Insider Weekly is also broadcast as follows:

  • Sunday at 5:30 a.m. on Comcast Channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.
  • 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 3:30 p.m.on Comcast Channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.
  • 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
  • Friday at 6:00 p.m. on Comcast and Astound channel 29 in San Francisco. Online streaming video at www.bavc.org, “public access TV”
  • Saturdays at 12:30 p.m. on Comcast Channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.

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!

Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

For your questions about dependent exemptions, see IRS Publication 501 at www.irs.gov.

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Questions and Answers

Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter. Email your questions to mgray@stockoptionadvisors.com.


My wife worked in a private IT company for more than six years. She was granted some stock options, most of which are vested by now. The employer company was sold to another private company.

After the dust settled, she and her co-workers learned their stock options are now worth almost nothing. She was given a letter to either exercise the options before the end of this month for 20¢ per share (to be repurchased by the employer company) or simply let them expire.

Does this sound shady? Can the stock options agreement let her previous employer do this?


You have asked a legal question that I’m not qualified to ask. You should consider consulting with an attorney, but it sounds like the amount you are dealing with won’t justify the expense.

There is no guarantee when you receive an employee stock option that it will become valuable. Most expire “underwater” or worthless.

Depending on the terms of the acquisition, I don’t think acquiring corporations are obligated to honor options granted by the companies they acquire, but most do.

Unless you have solid evidence of wrongdoing, 20¢ per share is better than nothing.

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Follow me on Twitter, Facebook or LinkedIn!

If you enjoy Twitter, please follow me at 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, www.facebook.com and www.linkedin.com/in/michaelgraycpa.

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Check out my blog.

I have also started a blog at 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.

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

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