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By Michael Gray

Table of Contents

• 5 year-end planning strategies for ISOs
• Happy Holidays
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert

5 year-end planning strategies for ISOs

Here are a few items to think about for working with incentive stock options or ISO stock as the year-end approaches.

1. If you exercised an ISO this year and the value of the stock has substantially declined since the date of exercise, consider selling the stock before the year-end. If you do so, you may qualify for the "escape hatch". The AMT preference is eliminated. You will report ordinary income based on the excess of the selling price over the option price. (Technically, it's the lesser of the excess of the fair market value or the selling price over the option price.)
   
   In order to qualify, the stock must be sold in the year of exercise in a transaction for which a loss would be recognized, if realized. This means a gift of the stock does not qualify for the ordinary income limit. It also means a wash sale of the stock will not qualify.
   
   Remember that a loss may not be deducted for a wash sale, which occurs when a taxpayer acquires or has entered into a contract or option to acquire substantially identical stock or securities during a period beginning 30 days before the date of the sale and ending 30 days after the sale. An acquisition of stock includes exercising an employee stock option. A common problem is buying stock through an employee stock purchase plan during the prohibited wash sale period.
   
   
2. Consider making a small exercise of "in the money" ISOs before the year end. You might be able to exercise some ISOs without incurring an AMT by using the AMT exclusion and ordinary income, such as wages, to balance the regular tax with the tentative AMT. This won't work if you have a big AMT credit carryover. It may not show up on your tax return except on the AMT credit form, but you continue to be an AMT taxpayer.
   
   
3. If you have an AMT capital loss carryover from the sale of depreciated ISO stock and you have an AMT credit carryover, look for capital gains to be realized before the year-end. The capital gains will be sheltered using your AMT credit carryover. This is one of a few ways to recover the credit in this scenario.
   
   
4. Watch "traditional" tax planning moves. If you are subject to the AMT or have a significant AMT credit carryover, it doesn't make sense to prepay state income taxes, property taxes or miscellaneous itemized deductions. They aren't deductible when computing the AMT.
   
   
5. Review your withholding and estimated tax payments. Many taxpayers who had a big tax liability for 2001 aren't paying their withholding or estimated tax based on last year's tax returns. To avoid penalties for underpayment of estimated tax, you should pay in at least 90% of the actual tax on your 2002 income tax return. I recommend that you try to pay 100%. It's better to "make up" prior period underpayments through withholding, because it's considered paid evenly throughout the year, even when there is extra-heavy withholding at the end of the year.

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Happy Holidays!

For many, this has been a tough couple of years. I believe better times are ahead and employee options will play an important part in building wealth for the next expansion.

Remember to keep the game in perspective. Your personal health and your relationships with your friends and families are the most valuable riches. "Seek first treasures in heaven, and these things will be added unto you."

We wish you and yours a joyous holiday season.

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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.

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(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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