Michael Gray, CPA’s Option Alert #101

An irregular alert for issues relating to employee stock options

June 6, 2012
© 2012 by Michael Gray, CPA
ISSN 1931-2768

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It’s time for tax planning and working on amended, extended and late income tax returns

Now that April 17 has passed, people are calling wanting a second look at the income tax returns that were filed for possible amended income tax returns. Taxpayers who filed extensions are also looking for help income getting their tax returns done.

If you would like our help, call Dawn Siemer on Mondays, Wednesdays and Fridays from 9 a.m. to 5:30 p.m. Pacific Time to make an appointment. Dawn’s telephone number is 408-918-3162.

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Second estimated tax payment is due June 15.

Remember the second 2012 estimated tax payment for most individuals, calendar year corporations, trusts, and estates is due June 15. California “front loads” 40% of the estimated tax in June for individuals and skips September.

If your estimated tax is not based on last year’s tax, you should be reviewing the amount to pay with your tax advisor for an “annualized” payment based on this year’s information.

Remember that individuals who have more than $1 million of income for 2012 aren’t eligible to base their estimated tax on last year.

Also remember that many individuals must make their California estimated tax payments using Web Pay. You can access Web Pay at http://www.ftb.ca.gov We recommend that you avoid using your credit card with this service, but have your bank account electronically charged instead. There is a substantial fee for credit card payments.

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“Substantial risk of forfeiture” definition proposed to be modified in Section 83 regulations.

The IRS has issued a proposed amendment to its regulations under Internal Revenue Code Section 83. This is the Code section that governs the taxability of property received as compensation for services, including stock grants and stock options. The default rule under Section 83(a) is that property is not taxable to an employee when it is subject to a substantial risk of forfeiture. An employee may elect under Section 83(b) to disregard the risk of forfeiture and have the income taxable at the time of the transfer (such an exercise of a non-vested nonqualified stock option).

The proposed changes mostly clarify the regulations in conformity with court rulings. For example, they indicate that “lock-up periods” are not a risk of forfeiture under these rules.

Three examples are added under the proposed regulations:

1) An employee lock-up period during an initial public offering is not a risk of forfeiture.

2) An insider trading compliance program, including trading windows for certain employees and liability under Rule 10b-5 of the Securities Exchange Act of 1934 are not risks of forfeiture.

3) An exercise by a corporate insider when there is not a condition of performance of future services (the shares are vested) and the period has expired when the transaction may be subject to liability under Section 16(b) of the Securities Exchange Act of 1934 is not subject to a risk of forfeiture.

The regulations are proposed to be effective January 1, 2013, but taxpayers may rely on them after they were published on May 30, 2012.

(NPRM REG-141075-09, May 30, 2012.)

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Option income received by nonresident of Oregon earned while a resident can’t be allocated to another state.

Domingo Garcia, Jr. became a resident of Oregon on May 29, 2006, when he started working at Nike. He received nonqualified stock options as part of his compensation from Nike. While working for Nike, he worked outside the state 391 days out of a total of 1,022 days worked. Mr. Garcia terminated his employment at Nike on September 17, 2010, and moved to Illinois on September 18, 2010. He exercised his options after he moved to Illinois.

Mr. Garcia claimed that only about 61.7% of his income from the exercise of the options should be taxable in Oregon, based on the ratio of the number of days that he worked in Oregon.

The Oregon Tax Court upheld the Oregon Department of Revenue in finding that, since Mr. Garcia earned the option income from his employment while he was a resident of Oregon, the income wasn’t eligible for allocation and was all taxable in Oregon.

(Garcia v. Oregon Department of Revenue, TC-MD 111074D, April 30, 2012.)

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California State Board of Equalization follows 9th Circuit in disallowing ISO claims.

Anthony Kadillak made a Section 83(b) election after exercising an incentive stock option during May 2000. As a result, he originally reported about $3,261,000 of AMT income. He was terminated in 2001, resulting in a forfeiture of some of the shares. He sold the rest in a private sale during 2002.

Mr. Kadillak filed amended income tax returns for 2000 and 2001, in which he claimed the Section 83(b) election was invalid and should be disregarded. Alternatively, he claimed he should be eligible to claim a net operating loss carryback for the losses suffered from the later sales of the stock, or a claim of right offset to reduce the tax for income that he ultimately didn’t receive.

The Franchise Tax Board suspended processing the returns until Mr. Kadillac completed litigation in the United States Tax Court and his appeal to the Federal 9th Circuit Court of Appeals was completed. Those courts rejected Mr. Kadillac’s claims.

When the Franchise Tax Board similarly rejected the amended income tax returns, Mr. Kadillac appealed to the State Board of Equalization. The State Board of Equalization followed the federal courts in rejecting Mr. Kadillac’s claims.

(Appeal of Anthony J. Kadillac, Case No. 536353, Adopted December 14, 2011.)

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California State Board of Equalization follows 9th Circuit in disallowing ISO claims.

Anthony Kadillak made a Section 83(b) election after exercising an incentive stock option during May 2000. As a result, he originally reported about $3,261,000 of AMT income. He was terminated in 2001, resulting in a forfeiture of some of the shares. He sold the rest in a private sale during 2002.

Mr. Kadillak filed amended income tax returns for 2000 and 2001, in which he claimed the Section 83(b) election was invalid and should be disregarded. Alternatively, he claimed he should be eligible to claim a net operating loss carryback for the losses suffered from the later sales of the stock, or a claim of right offset to reduce the tax for income that he ultimately didn’t receive.

The Franchise Tax Board suspended processing the returns until Mr. Kadillac completed litigation in the United States Tax Court and his appeal to the Federal 9th Circuit Court of Appeals was completed. Those courts rejected Mr. Kadillac’s claims.

When the Franchise Tax Board similarly rejected the amended income tax returns, Mr. Kadillac appealed to the State Board of Equalization. The State Board of Equalization followed the federal courts in rejecting Mr. Kadillac’s claims.

(Appeal of Anthony J. Kadillac, Case No. 536353, Adopted December 14, 2011.)

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Offshore account report is due June 30.

An annual report is required for offshore bank and brokerage accounts with combined balances at any time during the previous year exceeding $10,000 on June 30. The report is made to the Department of the Treasury using form TD F 90-22.1. You can get the form at the IRS web site, www.irs.gov. It is a separate report, not included with your federal income tax return. You may be required to file a report even if you don’t own an account, such as if you have signature authority as a corporate officer, executor or trustee.

The penalties for not filing are severe, so if you have a question about whether you are required to report, consult with a tax advisor. The “secret” Swiss bank account is a relic of the past.

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Beware of identity theft for your tax return.

More and more cases are being reported of tax refunds being delayed because someone else previously filed an income tax return with a taxpayer’s social security number. Be very careful with your birth date and social security number.

Also remember, the IRS doesn’t send notices by email or on social media sites.

Report suspected identity theft to the IRS at 800-908-4490.

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IRS Offers in Compromise relax somewhat.

Under an IRS Fresh Start Initiative, the IRS is relaxing its conditions somewhat for Offers in Compromise. Under an Offer in Compromise, the IRS agrees to accept an amount lower than the actual tax as a settlement of the balance. The IRS Fresh Start Initiative is an attempt to provide some relief to taxpayers who are suffering financial hardships due to the recession. You apply for an Offer in Compromise using Form 656 (available online at http://www.irs.gov).

Under the Fresh Start Initiative, the threshold for using an installment agreement without having to supply the IRS with a financial statement has been increased to $50,000.

A streamlined Offer in Compromise process is available for taxpayers with annual income up to $100,000 and tax liabilities of less than $50,000 – twice the old limit of $25,000.

When the IRS calculates a taxpayer’s reasonable collection potential, it will now look at only one year of future income for offers paid in five or fewer months, down from four years; and two years of future income for offers paid in six to 24 months, down from five years. All offers must be fully paid within 24 months of the date the offer is accepted.

The IRS is now permitted to consider the taxpayer’s credit card payments and student loans when computing the taxpayer’s living expenses.

The IRS accepted 27% of Offers in Compromise submitted in 2010 and 34% of offers in 2011.

This news offers hope to taxpayers who have been finding it difficult to pay off their obligations to the IRS.

(CCH Federal Tax Weekly, May 24, 2012, page 241, “Expanded IRS Fresh Start Initiative Revises IRS Program”. CCH Standard Federal Tax Reports Taxes on Parade, May 17, 2012, page 5, “IRS Cuidance Provides Offer in Compromise Specialists With Initial Contact Procedures”, IRS News Release IR-2012-53 (May 21, 2012. Also see SBSE 05-0512-045.))

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Financial Insider Weekly is broadcast in San Mateo County.

Financial Insider Weekly is now broadcast on PenTV, the public access television station for San Mateo County. The show is broadcast on Mondays and Fridays at 1:30 p.m. on Comcast channel 26 and Astound channel 27. Please tell your friends in San Mateo County!

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Community public access television needs our help.

Public access television is a vital part of our educational outreach to various communities. These are usually nonprofit, charitable organizations, like public television stations. Unlike those stations, most of the programming for the public access stations comes from local producers.

This programming includes the local arts, productions by students at local schools, community outreach by churches, independent local producers discussing current social issues, educational programming by local providers like ourselves and much more. In other words, public access television makes a unique, important contribution to the communities it serves.

With the difficult times we are experiencing, many public access stations are facing severe financial challenges, and might not survive without more community financial support. I urge you to consider making a donation to your local public access television station. Here is a link for a list of public access television stations in California:

http://www.communitymedia.se/cat/linksca.htm

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Financial Insider Weekly broadcast schedule for June and July.

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 June and July:

June 1, 2012, Don Pollard, CLU, ChFC, Advanced Professionals, “Group medical insurance for small businesses”
June 8, 2012, Michael Desmarais, attorney, “Your rights as a beneficiary”
June 15, 2012, Janis Carney, attorney, Carney, Sugai & Sudweeks, LLP, “Life care planning”
June 22, 2012, Janis Carney, attorney, Carney, Sugai & Sudweeks, LLP, “Veteran’s Administration benefits for long-term care”
June 29, 2012, Peggy Martin, CLU, ChFC, MSFS, The Family Wealth Consulting Group, “Long-term care insurance”
July 6, 2012, David Howard, attorney, Hoge, Fenton Jones & Appel, “Information reporting requirements for foreign bank accounts and foreign trusts”
July 13, 2012, James Brown, ASA, CFP(r), Perisho, Tombor, Ramirez, Filler & Brown, PC, “The role of the business valuation specialist”
July 20, 2012, Dean Fabro, Bank of the West, “Small Business Financing”
July 27, 2012, Francis Doyle, attorney, WealthPLAN, “Preserving family assets using a family limited partnership or LLC”

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
  • Monday at 1:30 p.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • 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. 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
  • Friday at 1:30 p.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • 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. 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
  • Saturdays at 9:00 a.m. and 6:00 p.m. on Midpeninsula Media Center, Comcast Channel 28 in Palo Alto, East Palo Alto, Stanford, Menlo Park & Atherton

Past episodes of Financial Insider Weekly are posted on YouTube. One way to watch them is to go to our web site, www.financialinsiderweekly.com, and click on “Past Episodes.”

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.

Question

I recently purchased vested NQO shares in my company and paid the appropriate withholding taxes. I plan to hold the shares. The price has already risen 15% since exercised, and future forecasts look favorable. I am waiting for a rainy day to sell the shares when the stock hits my target price.

When I sell, will I need to pay tax again on the difference between the option strike price and the current fair market value at sale, or just on the incremental gain since the purchase?

Answer

Just the incremental gain since the purchase.

The amount reported as income from the exercise of the option is added to the tax basis (cost for computing taxable gain or loss) of the stock.

See our free report, “Nonqualifed Stock Options – Executive Tax and Financial Planning Strategies” at http://www.stockoptionadvisors.com/isofaq/non-q_stock/

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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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