Michael Gray, CPA’s Option Alert #108
An irregular alert for issues relating to employee stock options
January 18, 2013
© 2013 by Michael Gray, CPA
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Table of Contents
- Tax preparation materials have been mailed
- Make your tax preparation appointment now
- Michael Gray quoted in San Jose Mercury News
- Please share your experiences with Michael Gray, CPA
- ‘Tis the season to exercise ISOs?
- Congress finally passes “Fiscal cliff” tax extensions
- The changing tax picture for planning with ESOs
- Elections briefly available for 2012 IRA distributions
- California disallows small business stock exclusion
- IRS privately rules fideicomiso is not a trust
- Proposed regulations issued for Medicare tax
- Supreme Court to hear Same Sex Marriage case
- 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
Tax preparation materials have been mailed
We have mailed online and paper tax organizer instructions to our clients. 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.
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.
Michael Gray quoted in San Jose Mercury News.
Michael Gray was quoted in two page one San Jose Mercury News articles, “Impass may put 2012 tax on table” on Friday, December 28, 2012 and “Take-home pay will feel pinch” on Thursday, January 3, 2013.
Please share your good experiences with Michael Gray, CPA.
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 experiences that you have had with our firm. Some of the sites where you can share your experiences include yelp.com, siliconvalley.citysearch.com, and Google+.
’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.)
Congress finally passes “Fiscal cliff” tax extensions.
President Obama signed the American Taxpayer Relief Act of 2012, HR 8, on January 2, 2013. This legislation solves the tax part of the “fiscal cliff” dilemma, but the budget part still remains to be done.
I have written a brief summary of the legislation.
Subscribers for the print edition of this newsletter will receive a printout of the summary.
The changing tax picture for planning with employee stock options
The tax picture is changing for ISO exercises during 2013. The maximum tax rate for ordinary income has increased from 35% in 2012 to 39.6% in 2013. The maximum tax rate for long-term capital gains has increased from 15% in 2012 to 20% in 2013, plus a 3.8% Medicare tax on investment income for high-income taxpayers. The maximum AMT rate is the same at 28%. The AMT exemption (finally!) will be automatically indexed for inflation (projected as $80,750 for married, filing joint and $51,900 for singles and heads of households), so we will be more confident of our tax projections for 2013.
(Note – the 3.8% Medicare tax has no relationship to the alternative minimum tax. It is a “surtax,” not an “income tax”. It appears to me the 3.8% Medicare tax will not apply to ordinary income from the disqualified disposition of ISO stock.)
Itemized deductions and personal exemptions for certain high income taxpayers will be phased out, effectively creating another tax bracket.
An additional 0.9% Medicare tax also applies to Medicare wages for certain high-income individuals.
We can’t kid ourselves. An increase in the tax rate for long-term capital gains for high-income taxpayers from 15% to 23.8% is significant and will have an impact on tax planning for employee stock options. The regular federal income tax rate increase to 39.6%, the 3% increase in the maximum California income tax rates (discussed below) and the 0.9% Medicare tax for high-income taxpayers reduce the benefits of non-qualified stock options and stock grants.
Also, the increase in the regular tax rate to 39.6% from 35% will have an impact on the alternative minimum tax computation. There is more of a “spread” between the regular tax rate and the minimum tax rate, which will create opportunities to reduce the alternative minimum tax by combining exercises of incentive stock options and non-qualified stock options. The increased regular tax rate will also create opportunities for recovering federal minimum tax credits that couldn’t be recovered before.
In addition to the federal tax rate increase, the maximum California tax rate has increased from 10.3% (including the mental health tax for taxable income over $1 million) to 13.3%. Since the California income tax isn’t deductible when computing the federal alternative minimum tax, we will see more taxpayers pay more federal alternative minimum tax, offsetting the AMT benefit of the 39.6% federal tax rate.
The changes in tax brackets will result in more focus on deferral strategies, including installment sales for stock that isn’t publicly traded, exercising options over more than one year, and using offsetting options, such as selling covered calls to capture the “option premium” or buying a put to “lock in” the sale price for selling stock in a later year. Non-qualified deferred compensation plans will become more popular for high-income taxpayers. Many high-income individuals will decide to replace their taxable bonds with municipal bonds. These strategies should be explored under the guidance of a skilled tax advisor, possibly together with a financial planner.
Elections briefly available to avoid tax for some 2012 IRA distributions.
The American Tax Relief Act of 2012 includes an election to exclude from taxable income certain IRA distributions received by individuals age 70 ½ or older, up to $100,000. One election is to treat direct distributions from an IRA to a charity made during January 2013 as a 2012 distribution qualifying for the exclusion. The second election is to treat IRA distributions made during December 2012 as qualifying for the exclusion provided the funds are transferred to a qualified charity by January 31, 2013. See your tax advisor for details.
California retroactively disallows qualified small business stock exclusion.
California’s Second District Court of Appeal ruled that California’s qualified small business stock exclusion is unconstitutional because it favors California corporations. (Cutler v. Franchise Tax Board (2012) 208 Cal. App 4th 1247.) The taxpayer was trying to challenge California’s exclusion so that it would be applied more liberally.
Unfortunately, the Franchise Tax Board says the ruling has the opposite effect. Since the statute is unconstitutional, it is invalid, unenforceable and ineffective. Nobody qualified for the exclusion.
For tax returns for taxable years beginning before January 1, 2008 that were accepted as filed, the statute of limitations has closed, so no action is necessary.
For tax returns for taxable years beginning before January 1, 2008 for which an audit, protest or claim is pending before the Franchise Tax Board, or for which an appeal is pending before the State Board of Equalization in which the qualified small business stock exclusion is at issue, the Franchise Tax Board will make an adjustment disallowing the exclusion.
For taxable years beginning on or after January 1, 2008, the statute of limitations is open. The Franchise Tax Board will issue a notice of deficiency for tax returns for which the exclusion was claimed. The Franchise Tax Board invites taxpayers to voluntarily file amended returns eliminating the exclusion.
(FTB Notice 2012-03.)
IRS privately rules fideicomiso is not a trust.
Certain foreign trusts are required to file an annual report with the IRS, Form 3520.
Mexico doesn’t permit non-Mexican citizens to own real estate within 100 kilometers of Mexico’s inland borders or within 50 kilometers of its coastline. When U.S. citizens own such property, a bank holds the title as trustee in a Mexican Land Trust or fideicomiso.
In the past, the IRS has informally said such a trust is a foreign trust subject to the reporting requirment.
Now the IRS has issued a private ruling that such a trust is similar to an Illinois land trust, and shouldn’t be treated as a foreign trust under Revenue Ruling 92-105.
A private ruling can’t be relied on except by the taxpayer who applied for it. Taxpayers who don’t file Form 3520 for a Mexican Land Trust and are challenged by the IRS could cite Revenue Ruling 92-105.
There are severe penalties for not complying with the reporting requirement. Hopefully the IRS will issue updated guidance that can generally be relied upon by taxpayers for this issue.
(Letter Ruling 201245003, July 30, 2012.)
Proposed regulations issued for Medicare tax.
The IRS has issued proposed reliance regulations for the 3.8% Medicare surtax on net investment income, which is effective on January 1, 2013. An important provision of these regulations is to permit regrouping of activities to avoid passive activity treatment.
In the past, taxpayers often weren’t concerned whether activities that were profitable were classified as non-passive, such as under the real estate professional exception. With the Medicare tax, the classification of activities as non-passive will become more important.
(NPRM REG-130507-11; NPRM REG-130074-11; Notices)(Dec. 3, 2012)
Supreme Court to hear Same Sex Marriage case.
The U.S. Supreme Court has agreed to consider whether the Defense of Marriage Act (DOMA) violates the Fifth Amendment’s guarantee of equal protection for same sex couples who are legally married under state law. The case relates to whether a New York same sex couple who were married in Canada may claim the marital deduction for the federal estate tax. (Windsor, CA-2, 2012-2 USTC ¶ 60,654.)
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 November and December.
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 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”
- February 1, 2013, attorney John Hopkins of Hopkins & Carley – “Succession planning for a family business”
- February 8, 2013, David Beck, CFP® of Bay Area Planners, “How to prepare for the challenge to families of financing a college education”
- February 15, 2013, Professor Patricia Cain of Santa Clara University School of Law, “Tax developments for same sex couples”
- February 22, 2013, Professor Patricia Cain of Santa Clara University School of Law, “Estate and gift tax planning for 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
- 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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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.)