Michael Gray, CPA’s Option Alert #91
An irregular alert for issues relating to employee stock options
May 23, 2011
© 2011 by Michael Gray, CPA
(If you find this information valuable, please pass it on to a colleague!)
Table of Contents
- Time for finishing extended returns
- Second estimated tax payment due June 15
- Foreign account report due June 30
- IRS voluntary compliance initiative for foreign accounts
- Restrictions disregarded in acquisition exchange
- Vesting is irrelevant for SEC Section 16(b) liability
- Financial Insider Weekly broadcast schedule
- Follow me on Twitter, Facebook and LinkedIn!
- Check out my blog
- Do you know about our other newsletters?
- IRS Circular 230 Disclosure
- Consult with a tax advisor
- Subscribe to Michael Gray, CPA’s Option Alert
Time for finishing extended returns, checking for errors and planning
Now that April 18 has passed, we are focusing on finishing extended income tax returns and tax planning. We have also had a number of people come to us for a second look at their 2010 income tax returns. They are questioning whether there are errors, and we have found some that will reduce tax bills. To make an appointment, please call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.
Second estimated tax payment due June 15
The second estimated tax deposit for individuals, most trusts and calendar year corporations is June 15. If you aren’t making your payments primarily through withholding from wages or making estimated tax payments based on your 2010 income tax returns (110% of last year’s tax liability if your adjusted gross income exceeds $150,000), you probably should make an annualized estimated tax payment based on this year’s income and deductions. We provide this service.
Remember that California taxpayers with gross income exceeding $1 million must base their estimated tax payments on current year income and deductions and don’t qualify for the exception based on last year’s tax return.
Also remember that many California taxpayers are now required to make their estimated tax payments electronically, usually using WebPay at www.ftb.ca.gov. The Franchise Tax Board is sending penalty bills to people who don’t make their payments electronically when they are required to. See your tax advisor to find out whether the requirement applies to you.
Foreign account report due June 30
The due date for 2010 Form TD 90-22.1, the report of foreign bank accounts and brokerage accounts owned outside the United States, is due on June 30, 2011. The due date can’t be extended. The IRS is on a compliance rampage for this form. Be sure to file it if it applies to you. (The highest total balance of foreign accounts that you own or over which you have signature authority is $10,000 or more.)
IRS voluntary compliance initiative for foreign accounts
If you missed filing the forms for foreign bank and brokerage accounts and for foreign trusts (Form 3520) in the past, the IRS has an initiative for you to “catch up” without fear of criminal prosecution. You are required to file the forms and amended income tax returns for any unreported income for the last eight years and to pay penalties. The forms must be filed and at least arrangements made to pay taxes and penalties by August 31, 2011. If you have (or might have) this situation, I recommend that you consult with a tax attorney who is familiar with the rules. The branch of the IRS that enforces the requirements is the Criminal Investigations Division.
You can find the questions and answers by going to the IRS website, www.irs.gov, and searching for “voluntary compliance initiative fbar”.
A very serious consequence for not complying is your tax return preparer may not be able to prepare your income tax return. See Q & A 47.
Restrictions disregarded in acquisition exchange
Danny Fort was a partner in the consulting division of Ernst & Young, an international CPA firm. In early 2000, the consulting division was sold to Cap Gemini, S.A., a French corporation. The partners of E & Y received Cap Gemini shares for their partnership interests. The shares were held in an escrow account at Merrill Lynch and were subject to restrictions.
The shares could be forfeited as “liquidated damages” if a partner (1) breached his employment agreement, (2) voluntarily left his employment, or (3) was terminated. The amount of forfeitable shares decreased each anniversary after the closing date of the sale. After a four-year, 300-day period, the partners could withdraw all remaining restricted shares from the account.
If a partner was terminated “for cause,” all of his forfeitable shares would be lost. If a partner ws terminated for “poor performance,” half of the forfeitable shares would be lost.
In consideration of the restrictions, the shares were valued at 95% of the closing price of Cap Gemini stock on the closing date.
Danny Fort was laid off in September 2003 because of downsizing, and didn’t lose any of his shares. The value of the shares had declined dramatically.
After reporting the entire agreed value of the shares as taxable income in 2000, Danny amended his income tax return to claim the restricted shares should not have been taxable income.
The IRS initially processed the refund, but later determined the refund was in error and filed suit to recover the refund.
The Eleventh Circuit Court of Appeals upheld a Federal District Court in finding in favor of the IRS. The courts found that Fort did not actually receive income from the restricted shares, but constructively received it.
The Court found that Fort had sufficient control over whether his shares would be forfeited. Cap Gemini didn’t use the poor performance provision to terminate partners for any reason at all, they were in fact terminated for cause and Fort didn’t in fact forfeit any shares.
This is not a taxpayer friendly decision and leaves an issue to be determined based on facts and circumstances whether income received and held in an escrow account pending certain requirements is currently taxable income.
(United States v. Fort, U.S. Court of Appeals, 11th Circuit, 2011- 1 U.S.T.C. 50,343.)
Vesting is irrelevant for determining SEC Section 16(b) liability
When determining when income from exercising an employee stock option is taxable, most restrictions other than vesting are disregarded. (§§ 83(a) and (c).) There is a statutory exception when the sale of the security may be subject to suit under Section 16(b) of the Securities Exchange Act of 1934. (§ 83(c)(3).)
Bernee Strom received stock options to purchase 750,000 shares at $15 per share when she was President and COO of Info-Space in November 1998. The shares vested over a six-year period, which could be accelerated if gross revenue and net income performance criteria were met. She exercised options in September and December 1999 and then almost monthly through July 19, 2000. In March 2000, the value of the stock began to rapidly decline. In early 2000, the price was in excess of $1,000 per share. By January 2001, the market value ranged from $55 to $64 per share.
Bernee asserted the valuation date for exercise of the options should be postponed until six months after the vesting date, because that was when the shares should be considered transferred under Section 16(b) of the SEC Act. Alternatively, the stock should be considered subject to restrictions because it couldn’t be transferred relating to a “pooling of interest” combination.
The Ninth Circuit Court of Appeals reversed a ruling of a Federal District Court and found the date of transfer under Section 16(b) was the grant date of the options. Therefore, that period had expired well in advance of the time Bernee exercised her options, and would not postpone the taxability of the exercise.
Since the District Court ruling primarily focused on the Section 16(b) issue, the Court of Appeals remanded the case to determine Bernee’s eligibility for a deferral relating to the restriction of transfer to qualify for a pooling of interest accounting method under Treasury Regulations Section 1.83-3(k). The restriction period is 30 days after a qualifying merger, and possibly 30 days before, much shorter than the Section 16(b) restriction period.
(Strom v. U.S., 9th Circuit Court of Appeals, 2011-1 USTC 50,319, April 14, 2011.)
Financial Insider Weekly broadcast schedule for May and June
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 May and June:
- May 25, William Mahan, Attorney, “Income and estate considerations of how you hold title to property”
- June 1, Naomi Comfort, Attorney, Hawks & Comfort, “How to handle retirement accounts after a death”
- June 8, G. Scott Haislet, Attorney and CPA, “Selling your principal residence”
- June 15, G. Scott Haislet, Attorney and CPA, “The short sale and foreclosure wars”
- June 22, Greg Carpenter, BTI Group Mergers & Acquisitions, “How to buy a business”
- June 29, David Howard, Attorney, Hoge, Fenton, Jones & Appel, “Reporting requirements for foreign bank and investment accounts”
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!
Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter. Email your questions to firstname.lastname@example.org.
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.
Check out my blog.
I have also started a blog at michaelgraycpa.com. Check it out!
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.
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.
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.
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.)