Michael Gray, CPA’s Option Alert #114

An irregular alert for issues relating to employee stock options

July 12, 2013
© 2013 by Michael Gray, CPA
ISSN 1931-2768

(If you find this information valuable, please pass it on to a colleague!)

Table of Contents

Extension season is here

If you would like us to prepare your extended 2012 income tax returns, please call Dawn Siemer Mondays, Wednesdays or Fridays from 9 a.m. to 5 p.m.

We can also prepare amended income tax returns to clean up tax returns that were previously filed.

Return to Table of Contents

Now is the time for tax planning

The year is already half over. How is it going? With many tax changes this year, especially for taxpayers with high incomes or high net worths, now is a good time for income and estate tax planning. To make an appointment, call Dawn Siemer Mondays, Wednesdays or Fridays from 9 a.m. to 5 p.m.

Return to Table of Contents

Planning reminders for incentive stock options

A key issue when planning for incentive stock options (ISOs) is the alternative minimum tax (AMT). In most cases, the federal alternative minimum tax is 28% of the excess of the fair market value of the stock on the later of the date of exercise or when the stock vests over the fair market value of the stock. An election is available under Internal Revenue Code Section 83(b) to disregard the vesting schedule and accelerate the application of the AMT.

A few states, including California, also impose an AMT when you exercise an ISO.

Since the accelerated income for the exercise of an incentive stock is a timing difference compared to regular tax reporting, a tax credit may be allowed when the ISO stock is sold. The credit becomes available because the income reported for AMT when the option is exercised is added to the cost of the stock for AMT reporting, so there is less gain and a lower computed AMT when the stock is sold. (Long-term capital gains are taxed at the same tax rate for both the regular tax and the alternative minimum tax.) The AMT credit is allowed up to the excess of the regular tax over the computed AMT in the year of sale.

The “brass ring” for holding stock after exercising an incentive stock option is the entire gain is taxed at long-term capital gains rates for the regular tax provided you meet the holding period requirements, more than two years after the option is granted and more than one year after exercising the option.

One problem of this system is you pay the federal AMT at 28% but the credit is limited to the tax rate that applies when the stock is sold, which may be 15% or 20% for a long-term capital gain, depending on your taxable income level. You may have 13% or 8% of unrecovered minimum tax credit, and may never recover it. (Effectively, you pay 28% of the spread at exercise, even when you meet the holding period requirements and even when you eventually sell the stock at a loss.)

There was a refundable minimum tax credit that enabled some taxpayers to recover the excess amount, but it expired after 2012.

A second problem is the new 3.8% surtax on net investment income. Long-term capital gains are subject to this surtax when you reach certain gross income levels – $200,000 for singles and $250,000 for married persons who file joint income tax returns. Since the net investment income tax isn’t part of the regular income tax, it isn’t eligible for offset by the minimum tax credit. Your effective tax rate relating to the exercise of the option and the sale of the stock are increased, reducing the tax benefit of holding the stock.

Meanwhile, there is a significant risk the value of the stock will decline while you are waiting to meet the holding period requirements. Are you going to have a Linked-In (value up) or a Facebook (value down)?

In many cases this isn’t a game worth playing, and you should just sell the stock when you exercise an ISO and pay the tax on the ordinary income. Consider prepaying the state tax to “match” it as a deduction against the ordinary income on your federal income tax return.

You might be able to hedge the position by buying puts or selling calls, but these create issues of possibly extending the holding period requirements to qualify for long-term capital gains. An alternative is to use puts and calls for a different but similar security for which price movements are correlated to the ISO shares.

The ordinary income from a disqualified disposition of ISO shares is not subject to the 3.8% net investment income tax, but could increase your adjusted gross income to a level where other investment income becomes subject to the tax. Although the ordinary income is treated as additional wages, it is not subject to employment taxes like social security, medicare or state disability income taxes.

The ordinary income from a disqualified disposition of ISO shares also isn’t subject to income tax withholding, so you might need to make estimated tax payments to avoid penalties for underpayment of estimated tax, and will certainly need to plan to pay the balance of the tax with your income tax return or extension by April 15 of the year following the year of exercise.

This discussion is greatly oversimplified. It’s best to work through tax projections with a tax advisor who is familiar with employee stock options (that’s our business!) when making decisions for a significant value of ISOs. If you would like our help with this, call Dawn Siemer at 408-918-3162 on Monday, Wednesday or Friday to make an appointment.

Return to Table of Contents

Colorado minimum tax credit a headache for nonresidents

I am currently wrestling with the Colorado Department of Revenue to document a minimum tax credit for clients (husband and wife) who formerly lived in Colorado and are now residents of another state. You have to document what the percentage of AMT income for an ISO exercise resulted in a Colorado AMT in the year of exercise. The credit may be recovered years after the AMT is incurred. Remember your tax returns are permanent records and to keep a copy. Fortunately, I have the copies (one of which I got from the clients) and I hope I will be able to satisfy the Department of Revenue so my clients get the tax benefit they are entitled to.

Return to Table of Contents

Should you terminate a bypass trust in light of recent tax law changes?

I have written a blog post on this subject.

Return to Table of Contents

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, Citysearch, and Google+.

Return to Table of Contents

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

Return to Table of Contents

Financial Insider Weekly broadcast schedule for July and August.

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 July and August:

July 12, 2013, Dick Blakeley, The Blakely Group, Inc., “How family business meetings can help avoid financial elder abuse”
July 19, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, “Asset class investing”
July 26, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, “Investment diversification using alternative investments”
August 2, 2013, Peggy Martin, MSFS, ChFC, CLU, The Family Wealth Consulting Group, “Socially Responsible and Sustainable Investing”
August 9, 2013, Professor Patricia Cain, Santa Clara University School of Law, “Tax Considerations of the Federal Supreme Court rulings on same sex marriages”
August 16, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, “How to make sure your retirement portfolio outlives you”
August 23, 2013, David Beck, CFP®, Bay Area Planners, “Funding For A College Education Using Federal Tax Benefits”
August 30, 2013, David Beck, CFP®, Bay Area Planners, “Government financial help for families of deceased veterans”

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 (Starting at 1 p.m. from June 15)

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!

Return to Table of Contents


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.

Return to Table of Contents


Follow me on social media!

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, www.linkedin.com/in/michaelgraycpa, and Google+.

Return to Table of Contents

Check out my blog.

I have also started a blog at michaelgraycpa.com. Check it out!

Return to Table of Contents

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.

Return to Table of Contents

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.

Return to Table of Contents

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.

Return to Table of Contents

(Michael Gray is the author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)

Comments are closed.