Michael Gray, CPA’s Option Alert #107
An irregular alert for issues relating to employee stock options
December 10, 2012
© 2012 by Michael Gray, CPA
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Table of Contents
- Happy Holidays!
- Our holiday schedule.
- It’s time for year-end tax planning.
- Give generously to help disaster victims in the Eastern U.S.
- Michael Gray interviewed on “Real Estate 360.”
- Michael Gray quoted in San Jose Mercury News.
- Please share your experiences with Michael Gray, CPA.
- “Fiscal cliff” directs more attention to year-end tax planning.
- Alternative minimum tax is a 2012 middle class tax problem
- 4th quarter estimated tax payment due January 15.
- First property tax payment due.
- Should you make additional tax payments before December 31?
- California passes individual tax increase.
- California “millionaire” taxpayers need to brace themselves for a big tax increase in 2013
- Medicare tax will change planning for employee stock options
- If you exercised ISOs during 2012, should you use the “escape hatch”?
- Should you donate appreciated publicly traded stock?
- Donating a car to charity?
- Community public access television needs our help.
- Financial Insider Weekly broadcast schedule.
- Follow me on social media!
- 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!
We hope you and your family enjoy a happy and safe holiday season, and that 2013 will be a health and prosperous year for you.
Our office will be closed December 24, 25 and New Year’s Day. Dawn Siemer will be on vacation for the last week in December.
With the holidays and continuing education classes in preparation for tax season, Michael Gray will have very limited availability for year-end tax planning meetings. Reserve your appointment now by calling Dawn Siemer on Mondays, Wednesdays and Fridays at 408-918-3162. Call Michael Gray directly on the days he is in the office after December 25 at 408-918-3161.
According to news broadcasts, Hurricane Sandy has inflicted devastating storm damage in the eastern U.S., particularly in Jersey Shore and New York City. Please give generously to the American Red Cross or your favorite relief organization to provide relief to victims of this disaster.
A one-hour radio interview of Michael Gray, mostly about investing using Roth and IRA accounts, by Lori Greymont on the “Real Estate 360” radio show will be broadcast on KDOW, 1220 AM, next Thursday, December 13 at 3 p.m. Pacific Time. KDOW is broadcast from Palo Alto, and can be heard throughout the San Francisco Bay area, and is also broadcast online at www.kdow.biz.
Michael Gray was quoted in the page one San Jose Mercury News article, “Coveted tax break in peril?” on Wednesday, November 28, 2012. The article was about a federal proposal to reduce the mortgage interest deduction.
As you know, more and more people are going to the internet to find information about service providers. We hope you will share some good words about good experiences that you have had with our firm. Some of the sites where you can share your experiences include Yelp, Citysearch, and Google+.
Most of us know the Bush federal tax cuts are scheduled to expire after 2012. In addition, a “patch” for the minimum tax exemption hasn’t been enacted for 2012, potentially exposing millions of taxpayers to an alternative minimum tax liability. Congress has made little progress since the election to solve these problems. As a result, unusual tax strategies are being examined, including considering accelerating income to 2012 and selling investments to report long-term capital gains in 2012. Also, individuals with large estates are aggressively making gifts in 2012. Consider discussing these issues with your tax advisor.
In California, the alternative minimum tax is a 2012 middle class tax problem
The Internal Revenue Service has warned Congress that the 2012 tax return filing season could be delayed if a “patch” isn’t enacted before the end of 2012.
The final estimated tax payment for individuals and calendar-year estates and trusts is due January 15, 2013. Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year’s facts. California passed a retroactive tax increase in the last election. There is no penalty for not paying the additional tax with your 2012 estimated tax payments, but you might want to do it for a deduction on your 2012 federal income tax return. Watch the alternative minimum tax. See your tax advisor.
The first property tax payment for the 2011-2012 fiscal year in Santa Clara County is due December 10. Avoid a late payment penalty – mail your payment early!
State estimated tax payments and early property tax payments made by December 31 are generally tax deductible for the regular tax. However, many people are finding they are subject to the alternative minimum tax. Deductions for taxes (and miscellaneous itemized deductions) aren’t allowed for the alternative minimum tax, so there could be no benefit for a tax prepayment. A tax advisor can project your tax picture to determine if the AMT will apply. Turbo Tax and other tax preparation software can also be used to make the computations.
California’s Proposition 30 passed in the November election. The proposition included a ¼% sales tax increase effective January 1, 2013 and expiring after December 31, 2016.
A privileged few will be affected by changes in the income tax rates, retroactively effective January 1, 2012 and expiring after December 31, 2018. Tax rate increases apply for singles and married persons filing separately with taxable income over $250,000, heads of household with taxable income over $340,000 and married persons filing joint returns with taxable income over $500,000.
California “millionaire” taxpayers need to brace themselves for a big tax increase in 2013
As you can see in the article about California tax changes above, taxpayers who file joint income tax returns with income over $1 million have a 3% retroactive California tax increase for 2012. The 3.8% federal Medicare tax is also becoming effective in 2013. (The Medicare tax will apply to investment income for taxpayers who file joint returns with adjusted gross income over $250,000.) So, even if Congress extends the Bush tax cuts, millionaire taxpayers will have about a 7% tax increase.
The income with the biggest hit may be qualified dividends. The special 15% tax rate for qualified dividends is scheduled to expire after 2012. That’s why shareholders are encouraging corporations to pay dividends that would otherwise be payable in 2013 to 2012. For 2011, the tax rates for qualified dividends were 15% federal plus 10.3% California, or about 25.3%. For 2013, the tax rates could be 39.6% federal regular tax plus 3.8% federal Medicare tax plus 13.3% California tax equals 56.5%. (The federal tax might be reduced for the tax benefit of the California tax deduction.) Let’s round the tax rate increase to 40%. That is about a 267% increase! Ouch!
If you are in the “million dollar taxable income club,” you should definitely be thinking about shifting income to 2012.
After 2012, I expect to see income shifting strategies become more popular, including deferred compensation, installment sales, tax free corporate reorganizations and tax-deferred exchanges. High income taxpayers will also sell their capital assets less frequently.
Medicare tax will change future planning for employee stock options
We’ll soon see what the tax rates will be for long-term capital gains after 2012. Meanwhile, the Medicare tax will definitely play a role in tax planning for employee stock options for higher income taxpayers. (More than $250,000 adjusted gross income for married, filing joint and more than $200,000 for singles.) The 3.8% Medicare tax will apply for long-term capital gains. We may see a 20% regular tax rate plus the 3.8% Medicare tax is 23.8% for a long-term capital gain, compared to a 28% alternative minimum tax when an ISO is exercised and the stock is held. The Medicare tax won’t be considered when determining the minimum tax credit to be recovered when ISO stock is sold.
It appears to me that ordinary income from the disqualified disposition of ISO stock isn’t subject to the Medicare tax. Ordinary income from a disqualified disposition of ISO stock is a special class of wages that isn’t subject to employment taxes. Ordinary income from exercising non-qualified options is subject to all employment taxes. An additional .9% Medicare tax will apply for additional wages of the high-income employee, including ordinary income from exercising a non-qualified option.
The Medicare tax is only part of the tax planning picture. Hopefully, Congress will soon fill in the details for tax planning for 2013, but long-term planning beyond a year will probably remain elusive. I expect Congress to enact major tax reform at the end of 2013.
If you exercised ISOs during 2012, should you use the “escape hatch”?
Remember if you exercised ISOs during 2012 and didn’t sell the stock, your AMT adjustment will be based on the fair market value of the stock on the date of exercise. However, if you sell the stock before the end of the year of exercise, the AMT adjustment is eliminated. Ordinary income is reported for the excess of the selling price over the option price. I call this strategy “the escape hatch.”
For example, Jean Employee exercised an ISO for 1,000 shares of XYZ stock on March 1, 2012. The fair market value of the shares on March 1, 2012 was $55 per share and the option price was $5 per share. If Jean didn’t sell the stock, she would report additional AMT income of $55 – $5 = $50 X 1,000 shares = $50,000. On December 15, 2012 Jean sells the stock for $15 per share. The AMT adjustment is eliminated and Jean reports $15 – $5 = $10 X 1,000 shares = $10,000 of ordinary income for regular tax and AMT.
There is an important requirement to get this tax benefit. A loss would have to be “allowable” if the stock was sold at a loss. A common transaction that would disqualify an escape hatch is a wash sale. A wash sale happens when replacement shares or an option to acquire replacement shares are acquired during the period 30 days before or 30 days after the sale.
For example, if Jean purchased 1,000 shares of XYZ Software for $16 per share on December 10, 2012, she would still have a disqualifying disposition of the ISO shares, but she would have $50,000 of ordinary income because the escape hatch wouldn’t apply. Her short-term capital loss of $15 – $55 = $40 X 1,000 shares = $40,000 would be disallowed as a current deduction. The disallowed loss would be added to the tax basis of the replacement shares. Therefore, the tax basis of the replacement shares would be $16 + $40 = $56 X 1,000 shares = $56,000.
It’s the season for giving. Many of us make extra donations during December to share our bounty with others. Appreciated publicly-traded stock that has been held for more than a year is an ideal asset for a donation. Under the Internal Revenue Code, the long-term capital gain is excluded from taxable income and the charitable contribution deduction is the fair market value of the stock, so there is a double tax benefit. Also, publicly traded stock isn’t subject to the appraisal requirements that apply for other property. It’s a win-win-win! Remember to get a good acknowledgement letter to document the donation, including a statement that “no goods or services were received in exchange for the donation”.
Remember that an appraisal is required for noncash contributions with a value exceeding $5,000. See Form 8283 and instructions as the IRS web site, http://www.irs.gov. (There is a Declaration of Appraiser on the form.) There is an exception to the rule for vehicles donated to a charity. If the charity sells the car, the taxpayer may rely on the sales price disclosed on Form 1098-C. The original Form 1098-C is submitted to the IRS with your income tax return (or otherwise sent to the IRS with Form 8453 if you efile.)
Community public access television needs our help
As you can see below, 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: www.communitymedia.se/cat/linksca.htm.
Financial Insider Weekly broadcast schedule for December and January
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 December and January:
- December 7, 2012, William Mahan, attorney, of counsel to Gates Eisenhart Dawson, “Why you need a will”
- December 14, 2012, William Mitchell, CPA, “I’m being audited by the IRS! What should I do?”
- December 21, 2012, William Mitchell, CPA, “I don’t agree with my IRS audit report. What should I do?”
- December 28, 2012, William Mitchell, CPA, “I owe back taxes to the IRS! What should I do?”
- January 4, 2013, attorney Mark Erickson, “Divorce – California style – Basics”
- January 11, 2013, attorney Mark Erickson, “Divorce – California style – The Family Business”
- January 18, 2013, attorney Mark Erickson, “Divorce – California style – The Family Residence”
- January 25, 2013, attorney John Hopkins of Hopkins & Carley – “How to promote community giving as a family value”
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 and broadcast on the internet at the same time as streaming video at www.mhat.tv
- Monday at 6:30 p.m. on Midpeninsula Media Center, Comcast Channel 28 in Palo Alto, East Palo Alto, Stanford, Menlo Park & Atherton
- 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 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County.
- Wednesday at 3 p.m.on Comcast channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola
- 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 11:30 a.m. on Comcast channel 27 in Santa Cruz County and Charter Communications channel 73 in Watsonville and Capitola
- Friday at 1:30 p.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
- Friday at 3:30 p.m. on KCAT, Comcast channel 15 in Los Gatos
- Friday at 4 p.m. on cable channel 15 in Cupertino, Los Altos and Mountain View.
- Friday at 6 p.m. on Comcast and Astound channel 29 in San Francisco, online streaming video at www.bavc.org, “public access TV”
- Friday 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
- Saturday at 9 a.m. and 6 p.m. on Midpeninsula Media Center, Comcast Channel 28 in Palo Alto, East Palo Alto, Stanford, Menlo Park & Atherton
- Saturday at 1:30 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County.
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!
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.
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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.
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.
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(Michael Gray is the author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)