Michael Gray, CPA’s Option Alert #164
An irregular alert for issues relating to employee stock options
January 9, 2018
© 2018 by Michael Gray, CPA
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Table of Contents
- Changes for my CPA firm
- LIVE seminar on new tax law highlights
- Tax preparation materials will soon be on the way
- Make your tax return preparation interview appointment now
- Fourth quarter estimated tax payment for non-corporate taxpayers is due January 16
- ‘Tis the season to exercise ISOs?
- Tax Reform and the alternative minimum tax
- Limited tax relief for some private company stock options, stock grants and RSUs
- Please share your good experiences with Michael Gray, CPA
- Financial Insider Weekly past episodes
- Follow me on social media!
- Check out my blog
- Interested in our other newsletters?
- Consult with a tax advisor
Changes for my CPA firm
As of January 1, 2018, I have sold my CPA practice to Ms. Thi Nguyen, MST, CPA with Koehler & Associates, CPAs, Inc. I will continue to work with Koehler & Associates in serving clients, when they need me.
I will also continue sending my newsletters for this tax season.
Thi’s telephone number is 408-286-7400, extension 206, and her email address is firstname.lastname@example.org. The address for Koehler & Associates is 1541 The Alameda, San Jose, CA 95126. The direct telephone numbers to Dawn and me are unchanged at 408-918-3162 and 408-918-3161. My new mailing address is 2482 Wooding Ct., San Jose, CA 95128.
This is a succession planning move, for the protection of my clients and my family. If you have a business, I hope you have a similar plan in place. I am doing this while I am still healthy to help ease the transition.
LIVE seminar on new tax law highlights.
The Silicon Valley, San Jose Chapter of the California Society of CPAs will have a live seminar on “Highlights of the Tax Cuts and Jobs Act.” The speakers are Michael Gray, CPA, Thi Nguyen, CPA of Koehler & Associates, CPAs, Inc. and Yaron Katz, partner from the Washington National Tax Office of KPMG. The presentation will take place from 8 a.m. to noon on Friday, January 19 at Los Gatos Lodge. Breakfast is included. Space is limited to 50 participants. The investment is $45 for members and $85 for nonmembers. Here is a link for registration information http://www.calcpa.org/events-and-programs or call Susie Riffel at 650-436-7169.
Tax preparation materials will soon be on the way.
For clients who have given their consent, Koehler & Associates is in the process of mailing instructions for sending their 2017 tax return preparation instructions. If you haven’t received instructions by January 20 or you would otherwise like to receive instructions, call Thi Nguyen at 408-286-7400, extension 206.
Make your tax return preparation interview appointment now.
Most personal interview appointments for preparing 2016 individual income tax returns will be scheduled in February. Many clients send their information without having an interview, but if you need that personal attention, you should schedule your interview appointment now. Call Thi Nguyen at 408-286-7400, extension 206.
Fourth quarter estimated tax payment for non-corporate taxpayers is due January 16.
The final 2017 estimated tax payment for individuals and calendar-year estates and trusts is due January 16, 2018. (Thank Martin Luther King’s birthday!) Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year’s facts.
If you miss the January 16 deadline, making a late estimated tax payment can stop penalties from accruing.
‘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.”
If the company’s stock isn’t publicly traded and you can’t sell the shares, this strategy won’t work.
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.)
See the two articles about Tax Reform legislation and consider how their interplay with exercising ISOs for 2018.
Tax Reform and the alternative minimum tax.
Congress passed and President Trump approved the Tax Cuts and Jobs Act during December 2017. The alternative minimum tax for individuals was NOT repealed in the legislation. Instead, the AMT exemptions for 2018 are increased to $109,400 (up from $84,500 in 2017) for joint returns and $70,300 (up from $54,300 in 2017) for singles and $54,700 (up from $39,375 for 2017) for married persons filing a separate return. The exemption amount phaseout thresholds are increased to 25% of alternative minimum taxable income exceeding $1,000,000 (up from $160,900 for 2017) for joint returns and $500,000 for all other returns (up from amounts ranging from $80,450 to $120,700 for 2017).
In addition, effective 2018, the following itemized deductions have been repealed or reduced, which would have been addbacks for computing the alternative minimum tax in the past: (1) the deduction for the combined amount of state income taxes and property taxes is limited to $10,000, (2) miscellaneous itemized deductions subject to the 2% of adjusted gross income floor, and (3) the mortgage interest deduction for up to $100,000 of equity lines used for a purpose other than home acquisition or improvement.
These changes will have a major impact on tax planning for incentive stock options. Many more ISOs can be exercised without incurring an alternative minimum tax.
See your tax advisor to make tax planning computations for how it will impact an ISO exercise for you for 2018. Tax planning software incorporating the changes might not be available for a few weeks.
Limited tax relief for some private company stock options, stock grants and RSUs.
Employees with stock based compensation with employer companies that aren’t publicly traded have always had a problem with having taxable compensation without receiving or having access to cash to pay the related income taxes.
The Tax Act and Jobs Act includes some tax relief for this situation, effective for options exercised and RSUs settled after December 31, 2017.
Certain employees can make an election under amended Internal Revenue Code Section 83(i) to defer recognition of the amount of income for qualified stock transferred to the employee by the employer. The election is effective for income tax purposes, not for computing FICA (Social Security and Medicare) or FUTA taxes.
The election must be made no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier.
When the election is made, the income is taxable for the earliest tax year that includes:
- The first date the qualified stock becomes transferable, including, for this purpose, to the employer.
- The date the employee first becomes an “excluded employee”. An excluded employee is an individual (i) who is a one-percent owner of the corporation at any time during the 10 preceding calendar years; (ii) who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation or an individual acting in either capacity; (iii) who is a family member of an individual described in (i) or (ii), or (iv) who has been one of the four highest-compensated officers of the corporation for any of the 10 preceding tax years.
- The first date on which any stock of the employer becomes readily tradable on an established securities market.
- The date five years after the first date the employee’s right to the stock becomes substantially vested; or
- The date on which the employee revokes his or her election.
If the election is made relating to a “statutory option” (ISO or ESPP), the option will no longer be treated as a statutory option but treated as a nonqualified stock option.
The employer’s deduction for the related compensation is also deferred until the employee is taxable for the income.
The election applies for qualified stock of an eligible corporation. A corporation is eligible for a tax year if: (1) no stock of the employer corporation or any predecessor is readily tradable on an established securities market during any preceding calendar year; (2) the corporation has a written plan under which, in the calendar year, not less than 80% of all employees who provide services to the corporation in the US or any US possession are granted stock options or restricted stock units (RSUs) with the same rights and privileges to receive qualified stock.
Employers are subject to notice, withholding and reporting requirements for the election. The IRS is given discretion to provide transitional relief for these requirements and will issue guidelines for them.
Note that key shareholders won’t get any relief and the participation requirements are very broad, which means this election may not really have a wide application. New stock compensation plans will have to be created to meet the requirements.
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Financial Insider Weekly past episodes
After eight years of production, I have discontinued producing new interviews for Financial Insider Weekly. Doing the show has been a rewarding experience and I consider back episodes to be my legacy of financial literacy education to our community. Past episodes are available at https://www.youtube.com/user/financialinsiderweek.
Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter. Email your questions to email@example.com.
See the books mentioned at www.employeestockoptionsecrets.com or the Special Report, Nonqualified Stock Options – Executive Tax and Financial Planning Strategies at www.stockoptionadvisors.com/non-q_stock.shtml.
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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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(Michael Gray is the author of Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.)