Michael Gray, CPA’s Option Alert #165
An irregular alert for issues relating to employee stock options
February 6, 2018
© 2018 by Michael Gray, CPA
ISSN 1931-2768
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Table of Contents
- Have you received your tax preparation materials?
- Make your tax return preparation interview appointment now
- File your tax return early, if you can
- Don’t report taxable income twice!
- Remember to report the sale of option stock
- Watch reporting qualified sales of ISO stock
- Please share your good experiences with Michael Gray, CPA
- Financial Insider Weekly past episodes
- Question and answer
- Do instructions on forms 6251 and 3921 conflict?
- Follow me on social media!
- Check out my blog
- Interested in our other newsletters?
- Consult with a tax advisor
Have you received your tax preparation materials?
If you haven’t received a tax data organizer or instructions to submit information online want tax return preparation service by my successor, Ms. Thi Nguyen, CPA, please call her at 408-286-7400, extension 206.
Make your tax return preparation interview appointment now
Most personal interview appointments for preparing 2017 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 Ms. Thi Nguyen, CPA at 408-286-7400, extension 206.
File your tax return early, if you can
Identity theft has become a rampant problem. Scammers are filing bogus income tax returns and claiming refunds for withholding and estimated tax payment of innocent taxpayers. It can take months to straighten out a duplicate filing situation. Your easiest defense is to be the first one to file an income tax return under your social security number. Individuals who have suffered from identity theft in the past can get a special identification number for electronic filing from the IRS. Meanwhile, many taxpayers must wait to receive documents like Schedule K-1 as late as September, and have to file for extension of time to file their tax returns.
Don’t report taxable income twice!
A common error for employees who exercise employee stock options is to report their income twice. Ordinary income from exercising a non-qualified stock option or from the disqualified disposition of stock received from exercising an incentive stock option should be reported by the employer on Form W-2. The ordinary income amount is added to the tax basis (cost for computing gain and loss on your income tax return), reducing or eliminating the gain reported for the sale of the stock. Brokerage companies can also miss this adjustment on the information return for the sale. This is especially a common error for employees who skip the “interview mode” when preparing their own income tax returns using software like TurboTax.
Remember to report the sale of option stock
Employees who exercise their stock options and immediately sell the stock sometimes omit reporting the sale of the stock. They figure the income is already reported on their W-2 form. They are essentially right, but the IRS “matches” the income reported on income tax returns with information returns for the sale of securities issued by brokerage companies. See the above information, “Don’t report taxable income twice!” If you add the option price to the ordinary income reported for the nonqualified stock option exercise or disqualified disposition of ISO stock resulting from an exercise and immediate sale, the cost should be equal to or slightly more (because of selling expenses) than the sales price of the stock.
Watch reporting qualified sales of ISO stock.
A common error for employees who make a qualified disposition of ISO stock is to add the AMT income reported for the year of exercise to the cost of the stock. (A qualified sale is made more than two years after the grant of the ISO and more than one year after the exercise of the ISO.) Employees rationalize they have already paid income taxes for that income. The tax they paid was on the alternative minimum tax schedule, not the regular tax schedule, so there is no regular tax basis adjustment for the exercise.
The mechanism for recouping some of the AMT paid when the ISO was exercised is the minimum tax credit, reported on Form 8801. A second AMT Schedule D is prepared for the year of sale with the basis adjustment added on the AMT Schedule D for the sale of the ISO stock.
Does this make your head spin? Maybe you should hire someone who understands this to prepare your income tax returns. Call Thi Nguyen, CPA at 408-286-7400, extension 206 to make an appointment.
Please share your good experiences with Michael Gray, CPA.
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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 mgray@stockoptionadvisors.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/stock/nqso-faq/.
Question and answer
Question
In the IRS instructions for form 6251, Line 14, it says to enter the fair market value of the stock acquired through exercise of the option… when your rights in the stock first became transferable…
BUT
The instructions for form 3921 for line 4 requires that the fair market value (FMV) of a share of the stock on the date the option was exercised be entered.
There is a substantial differences in these to FMV for the private stock I am holding.
Am I wrong to think that these two instructions conflict?
Answer
You are correct.
Form 3921 is an information return relating to the exercise of an incentive stock option. It doesn’t control what should be reported on the income tax return. It simply alerts the IRS that an ISO was exercised.
If the option wasn’t vested when exercised (an early exercise) and the employee makes a Section 83(b) election, excess of the fair market value on the date of exercise over the option price should be reported on Form 6251. Otherwise, the income is reported on Form 6251 based on the fair market value on the vesting date on the tax return for the year the stock vested after exercise.
If the stock was sold the same year an ISO was exercised, nothing is reported on Form 6251. The ordinary income reported on Form W-2 is also the taxable income for AMT reporting, so no AMT adjustment is required.
The rules for incentive stock options are confusing. That’s why it can be helpful to hire a CPA or other tax expert who understands how they work for preparing your income tax returns.
There is an important new election available for employee stock options in the Tax Cuts and Jobs Act. I summarized them in the January issue of Michael Gray, CPA’s Option Alert. It is available online at www.stockoptionadvisors.com/stock/optionalert/2018-01.
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 www.employeestockoptionsecrets.com or the Special Report, Nonqualified Stock Options – Executive Tax and Financial Planning Strategies at www.stockoptionadvisors.com/stock/nqso-faq/.
Follow me on Twitter, Facebook or LinkedIn!
If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.
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Check out my blog.
I have also started a blog at www.michaelgraycpa.com. Check it out!
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.
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.)