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By Michael Gray

Table of Contents

• Are Employee Options "Against The Ropes"?
• Another Proposal Introduced For AMT Relief For 2000
• Ignorance Is No Excuse - Employee Can't Revoke Section 83(b) Election
• Employer Can Apportion Stock Option Compensation
• Our web site operation will be changing
• For advisors, write about seminars and Advisors Inner Circle Membership
• For option holders, write about our self-study course
• Questions from readers

  Is my company required to hire an independent source to determine the fair market value of shares?

  How can I determine the fair market value of my options package?

  Is the price at par value when a company offers a stock grant?

  Can I sell my shares in a private company?

  Can I recover all the AMT I paid during 2002?

  Is there any tax due if I made an 83(b) election when the option price was the same as the fair market value?

  How are stock grants taxed?

• Consult a tax advisor

Are employee options "against the ropes"?

It's amazing how the option scene has changed during the last two years.

During the "Roaring Nineties," options were seen as currency. Everyone wanted them, even landlords as part of rent packages! There were proposals in Congress to create enhanced "super stock options."

Then came the market crash and the Enron scandal.

House Minority Leader Richard Gephardt, D-MO, and Senator John McCain, R-Ariz., have proposed establishing a commission to study and eliminate special tax breaks for businesses, including stock options.

The Ending the Double Standard for Stock Options Act, HR 4075 and Sen 1940 has been introduced in both houses of Congress. Under the proposed legislation, no tax deduction would be allowed for any amount of compensation relating to an employee stock option that isn't reported as an expense on the employer's financial statements. (If employers reported a compensation expense under the guidelines issued by the Financial Accounting Standards Board, the expense would not currently match the deduction under the tax laws. Even if they conformed to the financial reporting standards, employers would lose most of their deductions under the proposed tax law change.)

The IRS has proposed regulations to impose employment taxes at the exercise of incentive stock options and employee stock purchase plans.

Alan Greenspan and Warren Buffet have both endorsed requiring employer corporations to report expenses relating to employee stock option compensation.

It's clear the tone in Congress has become decidedly negative towards stock options.

Meanwhile, the High Tech industry is battling to preserve what it views as a key tool of its growth. There is an active lobbying effort in process to persuade our representatives not to kill the goose that laid the golden egg.

There is an old Chinese curse - "May you live in interesting times." These certainly are interesting times for employee stock options.

Be sure to express your opinion in this debate by writing to your representatives.

Another Proposal Introduced For AMT Relief For 2000

Senator Grassley and Senator Kerry have introduced Sen 1831. Under the proposal, employees would be able to determine the value of their stock for options exercised during 2000 as of April 15, 2001, instead of the exercise date, when computing the AMT adjustment.

It is interesting that the example given by the Senators was McLeod USA, a Cedar Rapids, Iowa corporation, a business outside Silicon Valley.

Ignorance Is No Excuse - Employee Can't Revoke Section 83(b) Election

An employee was given a "standard package" to exercise an incentive stock option. The package included a Section 83(b) election with a "sign here" sticker. The employee said he didn't understand the consequences of the election when he signed it. The employee paid a substantial alternative minimum tax relating to the exercise.

(When an employee makes a Section 83(b) election, the transfer of restricted property, such as unvested stock, is treated as a completed transaction. The amount of the AMT adjustment for the exercise of an incentive stock option is then based on excess of the fair market value on the exercise date over the option price. If the election wasn't made, the date of the transfer would be the date the shares were vested.)

The employee asked the IRS to consent to revoking the election as made under a mistake of fact, under regulations section 1.83-2(f).

The IRS ruled that ignorance of the law is not a mistake of fact, and denied the request.

(Letter Ruling 200212021.)

Employer Can Apportion Stock Option Compensation

An employer asked the IRS whether it was reasonable to apportion stock option compensation expense based on where an employee worked (in the US and overseas) during the stock option vesting period in order to determine foreign sales corporation income.

The IRS indicated it would be reasonable.

(Letter Ruling 200215010.)

Our web site operation will be changing

We have been offering all of the information on our web site for free. In order for ESOAA to be financially viable, we can't continue this practice. The current newsletter, our special reports and a few questions and answers will continue to be free. The rest of the site will be available on a subscription basis.

The details will be posted at the site.

For advisors, write for information about telephone seminars, live seminar and Advisors Inner Circle Membership

For information, send your name, company, address, email address, telephone number, fax number, and the specific information you are interested in to Dawn Gray at info@stockoptionadvisors.com.

For option holders, write for information about our self-study course about tax planning for employee stock options

For an information package, send your name, company, address, email address, telephone number and fax number to Dawn Gray at info@stockoptionadvisors.com.

Questions and Answers

Question

I have a few thousand non-qualified stock options from a start-up firm that I worked with until a few months agao. In mid-June, my rights to exercise these options will expire. The company is not publicly traded, probably has no revenue, and aside from some proprietary software, may have little value.

The option price is for a penny a share. I can exercise the options for less than $100. I understand I will have to pay a tax based on the value of the stock on the date of exercise.

Is the company required to hire an outside, independent source to determine the fair market value of the shares? How long is the valuation valid?

Answer

Employers whose stock is not publicly traded are given quite a bit of discretion in determining the value of their stock relating to employee stock options. They are not required to retain independent appraisers. They are required to make a "good faith" determination of value.

Typically, the board of directors declares a value for the stock for some period of time.

You should consult with whoever is in charge of administering employee benefits for your company to find out how your company handles this and the values to be used when you exercise your options.

In your case, it probably isn't worthwhile to get in a huge argument over this matter.

Question

I am trying to determine the fair market value of my employer-provided options package. My employer has publicly-traded stock. I have looked online for calculators, but none really fits my needs. Any suggestions?

Answer

I am not an expert in this area. Two pricing models for options are Black-Scholes and binomial option pricing. Try doing some research on those, including at your public library. Note the values determined using those models will be higher than the actual value, because your options aren't freely transferable.

If your options are substantial enough, you might look into hiring a business appraiser or a counselor that specializes in these arrangements.

Good luck!

Question

Is the price generally at par value when a company offers a stock grant?

Answer

"Par value" is usually a "stated value" per share. It doesn't really mean much, and most companies have "no par" stock.

For a stock grant, the employer is giving shares outright to the employee. The compensation amount is the excess of the fair market value on the date of grant, or when the option vests, if later, over any amount paid by the employee for the stock. If the stock is unvested, the employee may elect under Section 83(b) to treat the transfer as completed on the date of grant.

Question

I currently hold private stock in a company that most likely will not go public. I am looking to sell those shares. What are my options?

Answer

You might need to consult with an attorney familiar with corporate law. As I understand it, you may make a private sale of the stock to another shareholder or to the company. Be sure to study your stock certificates for any transfer restrictions that may apply.

Question

I have a question about the AMT credit.

Suppose I exercised ISOs with a fair market value greater than the grant price during 2001. If I hold the stock for a qualified disposition and sell it during 2002, will I be able to recover all of the AMT paid during 2002?

Answer

To get the answer, we would have to make computations for you with all of the figures for your projected income tax returns. Since the maximum AMT rate is 28% and the maximum regular income tax rate is 20%, it's hard to recover all of the AMT credit when the stock is sold. When the value of the stock goes down after the date of exercise, it's even harder. If the stock maintains it value, the amounts are fairly small and you have a lot of other ordinary income, it's possible to recover all of the credit.

Question

My son made an election within the 30 days for common shares. The shares were transferred on 6/25/01. The shares are subject to repurchase by the employer at the original price of 5¢ per share. The fair market value of the date of transfer was 5¢ per share. He cannot transfer his shares until they are no longer subject to repurchase. I do not see any gain. Is there any tax due?

Answer

Since it appears your son made a timely Section 83(b) election, any restrictions are disregarded. You specified the fair market value per share equals to purchase price of the shares, so there is no taxable income.

Question

I'm confused about what a stock grant is. From a tax treatment standpoint, is a stock grant considered the same as an ISO with zero cost basis or a NQSO with a zero basis?

Answer

A stock grant is not an ISO or a NQSO. For an analogy, it is taxed "like" a NQSO with a zero option price.

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Michael Gray regrets he can no longer answer emails personally. He will answer selected questions in this newsletter.

The answers to most questions can be found in our course, "Secrets of Tax Planning For Employee Stock Options". For details write Dawn Gray at info@stockoptionadvisors.com.

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

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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. We intend to eventually publish a directory of ESOAA members who are committed to helping clients with employee stock option issues.

Tax advisors should view the newsletter as an alert to become aware of issues relating to employee stock options for further research and study.

(Michael Gray is the co-author of Employee Stock Options – A Strategic Planning Guide for the 21st Century Optionaire. You can order the book at http://www.amazon.com or http://www.barnesandnoble.com/ or buy it at Stacey’s Books.)

P.S.

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