Michael Gray, CPA’s Option Alert #97

An irregular alert for issues relating to employee stock options

January 13, 2012
© 2012 by Michael Gray, CPA
ISSN 1931-2768

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Happy New Year!

The New Year is traditionally a time for setting personal and business goals. We hope we can play a part in that goal setting process, but more importantly in helping you achieve your goals. In any event, we hope 2012 will be a great year for you and your family!

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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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Last chance to get recordings of our “Year End Tax Planning For Employee Stock Options” teleseminar

If you weren’t able to participate in the telephone seminar about employee stock options on November 30, 2011, you can order recordings of the session until January 31, 2012. We are including two DVDs of interviews with option trader John Olagues and the book Executive Tax Planning For Employee Stock Options as bonuses.

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Final 2011 estimated tax payment is due January 17.

Remember the final estimated tax payment for calendar-year individuals, estates and trusts is due January 17. You might want to check with your tax advisor about reducing the payment if you had much lower capital gains in 2011 than in 2010, you are entitled to the increased federal refundable minimum tax credit, or your facts have otherwise changed.

Remember that California has a strange estimated tax deposit schedule. There was no payment due on September 15, but 30% of the estimated tax for 2011 is due on January 17, 2012.

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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‘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 excess 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” transaction. 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 payment requirements to avoid penalties for late estimated tax payments. (The alternative minimum tax liability can also be payable as an estimated tax liability.)

The tax picture is changing for ISO exercises during 2012. The maximum tax rate for ordinary income is scheduled to increase from 35% in 2012 to 39.6% in 2013. The maximum tax rate for long-term capital gains is scheduled to increase from 15% in 2012 to 20% in 2013, plus a 3.6% Medicare tax on investment income for high- income taxpayers. The maximum AMT rate is scheduled to remain the same at 28%. The AMT exclusion is up in the air for both years.

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AMT exclusion unknown for 2012

The federal AMT exclusion is one of the tax provisions that is unresolved for 2012. I don’t expect to see an extension of the increased exclusion passed by Congress until after the 2012 Presidential Election.

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Many tax provisions scheduled to expire after 2012.

The Bush tax cuts, including the 35% maximum tax rate on ordinary income and 15% tax rate on long-term capital gains is scheduled to expire after 2012. The $5 million lifetime exemption equivalent for gifts, estate tax and generation skipping tax is also scheduled to expire after 2012. A huge item scheduled to expire after 2012 is the exclusion from taxable income of cancellation of debt for a principal residence.

These changes will make it very difficult to plan for 2012. Many of these rules will probably be extended, but I don’t expect it to happen until after the 2012 Presidential election. Remember the old saying, nobody’s life, liberty or property is safe when Congress is in session.

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S corporation employee required to report income from option exercise

An employee of an S corporation made a cashless exercise of an option for the corporate stock. The Tax Court ruled the employee was required to report taxable income for the excess of the fair market value of the stock over the option price. The employee argued that the option wasn’t granted in connection with the performance of services, so the option wasn’t compensatory. The Court found the options were compensatory.

The employee also argued that the fair market value of the shares, which weren’t publicly traded, should be reduced for a 30% lack of marketability discount. The Court found the formula used to compute the value of the shares wasn’t determined by reference to the price of stock listed on a public exchange, so a lack of marketability discount wasn’t appropriate.

The IRS tried to disallow the deduction to the employer for the amount taxable as income to the employee, $36,962,694. The IRS claimed the compensation was excessive and shouldn’t be deductible. The Court found the option to be a form of contingent compensation that was the result of arm’s length or free bargaining, and therefore the employer was entitled to deduct the compensation resulting from exercising the option.

(Allen L. Davis, et al. v. Commisioner, T.C. Memo. 2011-286 (December 12, 2011.)

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Financial Insider Weekly time and day changes for Hayward, Alameda and Fremont.

Effective January 18, 2012, the days and times that Financial Insider Weekly is broadcast in Hayward, Alameda and Fremont will change to Wednesdays and Fridays at 8 p.m. The show is broadcast on Comcast channel 28 and, in California, AT&T U-verse channel 99 (Hayward).

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Financial Insider Weekly broadcast schedule for January and February.

Financial Insider Weekly is broadcast in San Jose and Campbell on Fridays at 8:00 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 January and February:

January 6, 2012, Scott Haislet, CPA and Attorney, “Real Estate Professionals and Passive Activity Losses”
January 13, 2012, Scott Haislet, CPA and Attorney, “1031 Tax Deferred Exchanges of Real Estate”
January 20, 2012, Bettie Baker Marshall, Attorney, “Caring for incapacitated family members and friends”
January 27, 2012, David Beck, CFP®, Bay Area Planners, “How a family can pay for a college education”
February 3, 2012, David Beck, CFP®, Bay Area Planners, “How tax benefits help finance a college education”
February 10, 2012, Hilary Martin, CFP®, The Family Wealth Consulting Group, “Planned saving to reach your financial goals”
February 17, 2012, Professor Patricia Cain, attorney, Santa Clara University, “Income tax problems of same-sex couples”
February 24, 2012, Professor Patricia Cain, attorney, Santa Clara University, “Estate and gift tax problems of same-sex couples”

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 (before January 18).
  • 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 4 p.m. and 7 p.m. Pacific Time on cable channel 19 in Morgan Hill. Broadcast on the internet at the same time as streaming video at www.mhat.tv.
  • Monday at 7:30 p.m. on Comcast channel 15 in Saratoga.
  • Tuesday at 4 p.m. and 7 p.m. Pacific Time on cable channel 19 in Morgan Hill. Broadcast on the internet at the same time as streaming video at www.mhat.tv.
  • Tuesday at 9:00 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County.
  • Wednesday at 8 p.m. (starting January 18) on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California.
  • 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 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 (before January 18).
  • 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”.
  • Friday at 8:00 p.m. (starting January 18) on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California.
  • 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!

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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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