Michael Gray, CPA’s Option Alert #135

An irregular alert for issues relating to employee stock options

July 8, 2015
© 2015 by Michael Gray, CPA
ISSN 1931-2768

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The year is half over!

Time is sneaking by us again! How is 2015 going for you? Is there any way we can help you reach your goals? How is your tax picture shaping up this year? Call Dawn Siemer at 408-918-3162 or Michael Gray at 408-918-3161 to make a planning appointment now.

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Dawn Siemer out of office.

Dawn Siemer will be out of the office from July 13, returning August 3. Please be patient with us while she’s away. It’s best to call Michael Gray directly at 408-918-3161 until she returns.

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Michael Gray out of office.

Michael Gray will be out of the office on July 13 and 14, returning July 15. He will respond to messages when he returns.

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Same sex marriages are now legal throughout the United States.

In what was probably the most historic Supreme Court ruling since approving inter-racial marriages during the 1960’s, the Supreme Court ruled in Obergefell that same-sex marriages are guaranteed by the Fourteenth Amendment to the United States Constitution.

Since the majority of states have already legalized same sex marriages, it appears this is an idea whose time has come.

From a tax perspective, our national tax system is now greatly simplified because everyone can now file their state income tax returns with the same status as married or not consistently with how they file their federal income tax returns.

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ISO stock exchange that wasn’t part of a qualified reorganization is a disposition

The IRS Chief Counsel has issued guidance that there is a disposition of stock acquired by exercising an incentive stock option (ISO) when the stock is exchanged relating to an acquisition that doesn’t qualify as a reorganization under Internal Revenue Code § 368. The fair market value of the stock received in the exchange plus any cash received will be treated as proceeds from the sale of the stock. If the holding period requirements aren’t met, the excess of the fair market value over the option price on the later of the date of exercise or the vesting date may be taxable as ordinary income as a disqualified disposition.

An exchange of stock as part of a qualified reorganization under Internal Revenue Code § 368 is not a disposition of the shares, except to the extent of any cash received.

(Letter Ruling 201519031.)

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Chief counsel advice details Section 409A nightmare for a non-qualified option

A corporation issued a non-qualified stock option for which the option price was below the fair market value of the stock. Therefore, the annual increase in the value of the stock became currently taxable to the employee under Section 409A, and subject to the 20% penalty tax plus additional interest income tax.

(Note that incentive stock options and employee stock purchase plans are required to be priced based on the fair market value of the stock. Employee stock purchase plans can have up to a 15% discount, and the fair market value can be determined on the grant (subscription) date or the date of exercise. If the shares are priced using a value below fair market value, the options won’t be “qualified options” and will be taxed as nonqualified stock options.)

The chief counsel clarified that stock traded on a when-issued, over-the-counter market is considered to be readily traded on an established securities market for the purpose of determining the fair market value of the stock as of the date of the grant of the option.

The grant date of the option was the date stated in the option agreement.

The income is computed for vested shares under the option. (Note that any shares for which a timely Section 83(b) election was made are treated as vested shares for income tax reporting purposes.)

Usually, the excess of the fair market value over the option price for the vested options is computed each year and the amount of income that was previously taxed is subtracted to determine the amount that is currently taxable. In this case, two years were closed under the statute of limitation, so the income that would have been taxable in those years would have escaped taxation. The chief counsel said the income for those years would not be subtracted when computing the taxable amount for the first open year.

Section 409A is a nightmare, and seems unfair because the penalties apply to the employee or business that received the option, not the company that issued the option. Companies should manage their stock option plans diligently to avoid having option recipients lose the deferral of their option income and being subject to the draconian penalties under Section 409A.

(CCA 201521013.)

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Should you consider using a Grantor Retained Annuity Trust to shift appreciation to other family members?

With today’s estate tax rules, a married couple can leave close to $11 million to their heirs without being subject to the federal estate tax.

Some public offerings result in stock for which the owners made a minimal investment becoming enormously valuable, far surpassing $11 million. Employees and shareholders holding stock with that potential should consider estate planning strategies to shift the increase in value to other beneficiaries.

I described some ways to do that in the last newsletter.

Another strategy where the stock holder doesn’t have to give the total investment away is a “grantor retained annuity trust” or GRAT.

One form of this strategy is called a “zero-out” GRAT, often for a short term, like two years.

In this case, an “annuity” just means a regular payment, and can be thought of as a note with equal payments made at least annually. Stock is transferred to an irrevocable (can’t be changed) trust in exchange for an annuity with an equivalent value to the stock transferred. Since an equivalent value is received in the exchange, the amount of the gift is zero.

This exchange should still be reported on a gift tax return in order to have the statute of limitations run on the transaction.

The remainder of the trust after the annuity is paid is distributed to other named beneficiaries.

When the stock isn’t publicly traded, it must be appraised. If cash isn’t generated to make the annuity payments, they can be made in property, such as a return of the stock. Another appraisal will have to be done when the payments are made when they are made with stock.

For income tax purposes, the person who created the trust, called the “grantor,” is treated as the owner of the trust. Any income or deductions of the trust will be reported on the grantor’s income tax return.

If the grantor dies before the annuity is paid, the present value of any unpaid annuity payments is included in the grantor’s taxable estate.

To avoid estate inclusion, GRATs are often made for short terms, and multiple GRATs may be set up with different maturity dates, or “rolling GRATs.”

Short-term GRATs are a target for tax reform. The Obama administration would prefer to have a minimum of a 10-year term for GRATs. This would increase the risk the grantor could become subject to income tax if the company is acquired before the term of the trust expires, and that some or all of the GRAT could be included in the grantor’s taxable estate.

This is a greatly simplified explanation. There are many alternative structures for GRATs. Be sure to have good professional advice when creating and operating a GRAT.

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Does your group need a speaker?

We are seeking opportunities to speak before groups. Topics include recent tax developments, tax issues relating to real estate, how estate planning has changed recently, tax issues relating to alternative investments using retirement accounts, and marketing topics such as “How I created a public access television show broadcast on eleven Bay Area stations.” To make arrangements, call Michael Gray at 408-918-3161.

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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+.

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Financial Insider Weekly broadcast schedule for July and August.

Financial Insider Weekly is broadcast in San Jose and Campbell on Fridays at 9:30 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 10 and 17, 2015, Jeffrey Hare, APC, attorney at law, “Settling legal disputes our of court”
July 24 and 31, 2015, Lori Greymont, CEO, Summit Assets Group, “Real estate investment alternatives”
August 7 and 14, 2015, Nancy Ross, Bauer Shepherd & Ross & Associates, “How a collaborative approach can make divorce a less painful process”
August 21, 2015, Janis Carney, attorney at law, Carney Elder Law, “Senior Estate Planning”
August 28, 2015, Janis Carney, attorney at law, Carney Elder Law, “Caring for seniors today: challenges in getting quality care”

Financial Insider Weekly is also broadcast as follows:

  • Sunday at 10:00 a.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • Sunday at 1 p.m. on Comcast channel 26 in Santa Cruz County and on Charter Communications Channel 72 in Watsonville and Capitola
  • Monday at 7:00 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
  • Monday at 10:00 a.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • Tuesday at 10:30 a.m. on Comcast channel 26 in Santa Cruz County and on Charter Communications Channel 72 in Watsonville and Capitola
  • Tuesday at 2:30 a.m. and 12:30 p.m. on Midpeninsula Media Center, Comcast Channel 28 in Palo Alto, East Palo Alto, Stanford, Menlo Park & Atherton
  • Tuesday at 7:00 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

  • Wednesday 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
  • Thursday at 10:00 a.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • 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 4:00 p.m. on KMTV cable channel 15 in Cupertino, Los Altos and Mountain View
  • 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
  • Saturday 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
  • Saturday at 10:00 a.m. in San Mateo County on PenTV, Comcast Channel 26 and Astound Channel 27
  • Saturday at 1:00 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!

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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.

See the books mentioned at http://http://www.siliconvalleypublishingcompany.com/products/secrets-of-tax-planning-for-employee-stock-options-2014-edition or the Special Report, Nonqualified Stock Options – Executive Tax and Financial Planning Strategies at http://www.stockoptionadvisors.com/stock/nqso-faq/.

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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+.

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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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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 to the right.

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