Michael Gray, CPA’s Option Alert #90

An irregular alert for issues relating to employee stock options

March 9, 2011
© 2011 by Michael Gray, CPA
ISSN 1931-2768

(If you find this information valuable, please pass it on to a colleague!)

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Tax season is here! Make your appointment now!

There are less than six weeks before April 18.

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!

We expect to file for extensions when we receive clients’ tax information after March 15.

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Restrictions disregarded for taxability of stock grant

The Second Circuit Court of Appeals upheld a Federal District Court ruling against a taxpayer relating to the taxability of a stock grant. The taxpayers, Olafur Gudmundsson and Sally Rudrud, received a stock grant from Olafur’s employer, Aurora Foods, Inc. shortly after a public offering of Aurora’s stock. (Aurora markets brand name foods like Aunt Jemima, Duncan Hines and Van de Kamp.)

The stock received was subject to restrictions from sale on a public exchange for one year after receipt under SEC Rule 144. The stock was also subject to corporate agreements restricting sale or transfer for a period of time.

During the time the restrictions applied, the stock did poorly. Irregularities were discovered in the company’s financial statements.

The stock, valued at $17.6875 per share when issued fell to $3.8375 when the restrictions lapsed.

The taxpayers argued the shares shouldn’t be taxable until the restrictions lapsed. Alternatively, the taxpayers argued the valuation of the shares should be reduced to consider the effect of the restrictions and the limited market for the shares.

The Court of Appeals upheld the District Court and the IRS in finding the statutory language of Internal Revenue Code Section 83 states that temporary restrictions other than vesting and SEC Section 16b are disregarded in determining the timing of taxability and valuation of compensatory shares.

There are many similar rulings. These rules are unfair and should be revisited. It won’t happen unless taxpayers and their advisors complain to Congress. A problem is Congress views stock compensation as a “fat cat” benefit, so Congress isn’t sympathetic when taxpayers are hurt by laws like this one.

A suggested alternative for legislation postponing the taxability of the transfer until temporary restrictions lapse would be to let taxpayers claim an ordinary loss for the sale of the shares up to the amount of compensation reported. Then a taxpayer can carry a net operating loss back to recover taxes previously paid.

(Gudmundsson, U.S.T.C. 50,218 (February 11, 2011.))

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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.

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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 2010 individual income tax returns is for six months to October 15, 2011.

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 2009, 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 18. (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 2009 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. To avoid service charges, you may be able to designate a bank withdrawl on an efiled extension form or use the EFTPS system if you are already set up. 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 can actually 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 18

(This is a reprint from past newsletters.)

Remember to review your estimated tax situation for 2011.

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.

Also remember that California now requires taxpayers with more than $1 million of adjusted gross income, or who were required to make electronic payments before, to make their estimated tax payments electronically. The payments can be withdrawn directly from your bank account using Web Pay at www.ftb.ca.gov. Once you do it a couple of times, it won’t seem so bad.

When you make payments using a credit card, there is a stiff service charge, so do it sparingly.

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 2010

Remember the final due date for IRA and Roth contributions for 2010 is April 18, 2011. 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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Financial Insider Weekly broadcast schedule for March and April

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 March and April:

March 9, Lamarr Baxter, Entrust Administration, “Making alternative investments besides real estate using your IRA or Roth Account”
March 16, Professor Patricia Cain, Santa Clara University, “Income tax problems of same sex couples”
March 23, Professor Patricia Cain, Santa Clara University, “Estate and gift tax problems of same sex couples”
March 30, Don Pollard, Advanced Professionals, “Individual medical insurance.”
April 6, Don Pollard, Advanced Professionals, “Business group medical insurance”
April 13, Tom Oviatt, Wymac Capital, “Home mortgage market developments”
April 20, Greg Carpenter, BTI Group M & A, “How to prepare to sell a business”
April 27, Phil Price, EA, The Price Company, “Qualified retirement plans for small businesses”

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
  • 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”.

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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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.


I left my privately-held employer in 2010 and purchased my vested shares for $5,200. (43,000 shares at 12¢ per share.) However, as the company is privately held, they have no real value right now. Do I need to declare this stock on my income tax returns?



The item is only reportable if the fair market value of the stock exceeds the option price. You should have received some reports from your company about what the fair market value of the stock was and the reportable amounts.

If the options were nonqualified stock options, the income (for the excess of the fair market value of the shares over the option price) should already be reported on your Form W-2.

If the options were incentive stock options, the excess of fair market value over the option price is reported on the Alternative Minimum Tax Form, Form 6251.

See the Gudmundsson case above. Most restrictions are disregarded in determining whether stock received as compensation is taxable.

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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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