Michael Gray, CPA’s Option Alert #169

An irregular alert for issues relating to employee stock options

June 6, 2018

© 2018 by Michael Gray, CPA

ISSN 1931-2768

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It’s time for cleanup and extensions

Maybe you have an issue for which you would like a second look on the income tax returns you just filed. Maybe you have extended income tax returns that you need to have prepared. Or maybe you have some planning issues for which you need advice. To make an appointment, call Thi Nguyen, CPA at 408-286-7400, extension 206.

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June 15 is an estimated tax due date

The second estimated tax payment for most individuals and calendar year corporations and fiduciaries is June 15.

For individuals, federal estimated tax payments (for estimated tax exceeding withholding) can be based on 110% of 2017 tax on your income tax return if your adjusted gross income exceeds $150,000. Alternatively, you can make payments based on your income and deductions for 2017.

The California payment is 40% of estimated tax for the year. Like federal estimated tax payments, California payments can be 110% of 2017 tax, unless your adjusted gross income is $1 million or more. In that case, your estimated tax payments should be based on your actual income and deductions for 2018.

For help computing your second quarter estimated tax payments, call Thi Nguyen at 408-286-7400, extension 206 to make an appointment for a consultation.

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Do you love travel?

I have created a Facebook travel group, called Travel Adventures, for members to share travel photos, experiences and tips. If you are on Facebook, you can use this URL to join: https://www.facebook.com/groups/207423476536726/, or search “Groups” on Facebook. You have to use the “join” button to join the group. This is a closed group, and I will approve your membership.

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Do you love Disney?

I have created a Facebook group, called Disney Magic, for members to share Disney photos, experiences and tips. I am also posting developments for Disney films, television shows, and amusement parks there. If you are on Facebook, you can use this URL to join: https://www.facebook.com/groups/2006739209578437/, or search “Groups” on Facebook. You have to use the “join” button to join the group. This is a closed group, and I will approve your membership.

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Some lifetime gift planning strategies for employer stock

This is a reminder of some lifetime gift strategies. See your estate planning attorney and tax advisor for details. Remember that reporting transactions on a gift tax return may apply. Also, tax laws vary among the states. For example, California doesn’t have a gift tax, but other states do.

First, get your house in order. If you don’t have a will and trust, get them in place. Should you increase your life insurance coverage? Who will care for your children and how your family will be provided for if something happens to you and/or your spouse is more important than other estate planning concerns.

Also, provide for your own needs first. It doesn’t make sense to give your assets away and leave yourself financially destitute. (Medicare planning is another matter. Your parents or grandparents might need to consult with an Elder Law attorney about that.) Most clients that I work with already have plans for the money they will receive from employee stock options, including using it as a down payment for a home. No fancy estate planning required in that case.

The estate planning picture has dramatically changed under the Tax Cuts and Jobs Act of 2017. The combined estate tax exclusion for a married couple is more than $22 million for 2018, but will be scaled back after 2025. With the “portability election,” the exclusion for the last-deceased spouse carries to the surviving spouse. You don’t have to create a “bypass” or “credit shelter” trust in order to preserve an estate tax exclusion, but you still might want to.

With the high lifetime exclusion plus $15,000 per donor (for 2018), per donee annual exclusion, significant transfers can be made with zero out of pocket tax cost. (Transfers to some trusts may not qualify for the gift tax annual exclusion.)

For most taxpayers, the focus has changed to income tax planning. When a taxpayer dies, the tax basis for most assets (cost for reporting gain or loss when an asset is sold) is adjusted to the fair market value at the date of death. That means most people will not be concerned with shifting assets or appreciation to avoid gift and estate taxes. There can still be income tax benefits for shifting gains to family members in low income tax brackets. (But watch out for the “Kiddie Tax” that can apply to children up to age 23! The child is taxed at the parents’ marginal tax bracket.)

The simplest way to shift appreciation to a family member is by making a loan. The loan should be documented with a written note. The IRS specifies “applicable federal rates” for the minimum interest to be charged on loans. For June 2018, the applicable federal rate for a five-year loan with annual compounding of interest is 2.86%. (It will increase as the Federal Reserve raises the discount rate.) The borrower can invest the loan proceeds into stock (or another investment) that will hopefully appreciate more than the interest amount. The risk is the investment can go down in value.

Another fairly simple way to shift appreciation to a family member is with an installment sale. The installment note must bear interest of at least the applicable federal rate. Founder’s stock could be sold to a family member. If the stock isn’t publicly traded or the stock value goes down, the family member may find it hard to pay off the loan on time. If the value of the stock goes up and there is a liquidation event before the due date of the note, the family member wins. The eventual sale of the stock may result in long-term capital gains in a lower tax bracket. The appreciation will be excluded from the selling taxpayer’s taxable estate. If the stock isn’t publicly traded, an appraisal will probably have to be done to establish the sale was made for fair market value. Appraisals are expensive, so the transaction should be sizable enough to justify the expense. It’s also a good idea to report installment sales to family members on a gift tax return so the statute of limitations will run and the IRS won’t be able to re-examine the transaction more than three years after the gift tax return is filed.

For the last two strategies, the transferor gets his or her principal back, plus some interest. The next simple strategy is to make an outright gift of stock of an appreciating asset. When an asset is expected to appreciate rapidly, it can make sense to transfer it to a family member at a current low value and avoid having the appreciation in your estate. I have had clients transfer millions of dollars in appreciation to their children and other family members by making gifts of start-up stock or other appreciating investments. Be aware that a transfer of ISO stock can be a disqualified disposition, resulting in taxable ordinary income. For stock that isn’t publicly traded, an appraisal will be required. Again, to get the statute of limitations running, even gifts of stock of less than $15,000 per donor, per donee should be reported on a gift tax return. Also, there may be legal issues relating to transferring stock that isn’t publicly traded. You will probably have to get the consent of the company that issued the stock. Get legal counsel.

Now you have three simple strategies for transferring appreciation to other family members. Always get tax advice when you implement them.

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California Supreme Court ruling could create employee classification headaches

Under a recent California Supreme Court ruling for the Dynamex case, many more workers currently treated as independent contractors could be reclassified to be employees.

According to the Court, a worker must meet three tests to qualify as an independent contractor:

  1. The worker must be free from the control and direction of the hiring entity in connection with the performance of the work.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

The real problem is the second requirement. Under this requirement, an independent professional performing temporary work would be considered to be an employee. Many independent contractors that work for a single “customer” could be considered to be employees.

This case related to delivery drivers who claimed to be transportation industry employees.

The California Employment Development Department is probably sharpening its knives to apply this ruling.

San Francisco City Attorney has issued subpoenas to Uber and Lyft to examine whether their contract drivers are actually employees under the Dynamex ruling.

Watch for an appeal and more litigation on this issue, which is a critical one for the tech industry and many small businesses.

(Dynamex Operations West, Inc. v. Superior Court, County of Los Angeles, Supreme Court of California, No. BC332016, April 30, 2018. San Jose Mercury News May 31, 2108, p. C11, “Uber, Lyft subpoenaed on driver wages”.)

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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.

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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 www.employeestockoptionsecrets.com or the Special Report, Nonqualified Stock Options – Executive Tax and Financial Planning Strategies at www.stockoptionadvisors.com/stock/nqso-faq/.

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Check out my blog.

I have also started a blog at www.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 below.

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

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