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Table of Contents

• Third quarter estimated tax payments are due
• Calendar year non-corporate income tax return due date
• Buying NQOs using margin account doesn't defer tax
• Questions and answers
• Do I need to file Section 83(b) election?
• What are the tax implications of cashless NQO exercise?
• What are the tax implications of giving ISO shares?
• What is the holding period for ISOs?
• How will a stock split affect my ISO?
• Do you know about our other newsletters?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert

Third quarter estimated tax payments are due

The third quarter estimated tax payment for calendar year entities, including most individuals, is due on September 15. Some taxpayers with irregular income make payments based on their actual information for the year. If this applies to you, get in touch with your tax advisor now. If we can be of service to you in this area, call Dawn Siemer at 408-918-3162 for an appointment.

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Not much time left for calendar year non-corporate taxpayer income tax returns

The extended due date for calendar year noncorporate taxpayers, including most individuals, partnerships, estates, and trusts is October 15. That is also the extended due date for making deductible employer payments to qualified retirement plans of these entities, including Keoghs, SEPs, defined benefit plans, profit sharing plans, ESOPS and 401(k) plans. The extended due date for 2005 gift tax returns is also October 15. This is a critically important due date, so please be sure your income tax returns are filed on time. In some situations, penalties can even be imposed when there is a tax overpayment. If we can be of service to you in this area, call Dawn Siemer at 408-918-3162 for an appointment.

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Buying NQOs using margin account doesn't defer tax

The Tax Court, citing its previous decision in Facq, (see Option Alert #29, June 14, 2006) issued a memorandum decision that exercising non-qualified options using non-recourse funds from a margin account does not defer taxable income from the exercise. The loan was secured by the option stock.

According to the Tax Court, the taxpayer had sufficient control of the shares, including the right to borrow against them, for the transfer to be considered completed.

The Court distinguished an example in the regulations where the employer corporation made a non-recourse loan to an employee to purchase the shares. Since the loan in the example came from the employer corporation and the employee wasn't personally liable for its repayment, that loan would be considered to be another option and the transfer of shares wouldn't be considered completed.

The Court waived an $102,892.40 proposed accuracy penalty because the taxpayer acted with reasonable cause and good faith. The taxpayer relied on a tax attorney to prepare an amended return stating the income wasn't taxable when the options were exercised. At the time the amended return was filed, cases on the issue of purchasing non-qualified stock options had yet to be litigated.

(Racine v. Commissioner, T.C. Memo. 2006-162, August 14, 2006.)

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Questions and Answers

Question

I recently voluntarily terminated employment at a private company. Some of my vested stock options have an option price of $1 per share and others have an option price of 50¢ per share. I chose to exercise some of the stock options with a 50¢ option price.

The option price is higher than the estimated fair market value of the stock.

Do I need to file any forms, like a Section 83(b) election for exercising the options? Is there an AMT issue for exercising the options?

Answer

Since you exercised the options after terminating your employment, the shares must be fully vested. No Section 83(b) election is available. The AMT issue principally relates to the exercise of incentive stock options where the fair market value of the stock exceeds the option price. Since you tell me the option price exceeds the fair market value of the stock, there should not be an AMT issue relating to the exercise.

Question

My company compensated me with some NQSOs. What are the tax implications if I do a cashless transaction to exercise and sell at the same time?

Answer

See our free report, Executive Tax Planning for Non-Qualified Stock Options.

Question

I was granted a stock option at $2 per share two years ago. I exercised the option one year ago when the fair market value of the stock was $12 per share, and paid an AMT. I then gave some of the shares to my relatives, and the value is $14 per share. What are the tax implications?

Answer

You're supposed to ask before going ahead with a transaction. Since you reported an AMT adjustment, these must have been incentive stock options. Assuming you gave the shares before more than one year had expired after the exercise, you have made a disqualifying disposition of the ISO shares. Ordinary income is reported based on the $10 per share adjustment when the option was exercised. There will be an offset on AMT form 6251, with an AMT credit on Form 8801. If the shares transferred had a value of more than $11,000 for any donee, you are required to file a gift tax Form 709.

Question

I am getting different advice from different CPAs about the holding period for ISOs. As I understand it, to avoid a disqualifying disposition, I must hold the stock beyond the later of the following two dates: (1) One year after the date the ISO is exercised; or (2) Two years after the date the ISO is granted.

Two CPAs told me I must satisfy both requirements and two other CPAs told me only one requirement needs to be satisfied.

I was granted ISOs on August 3, 2001. These shares are now 100% vested. I haven't exercised the ISOs yet. Do I still have to wait more than one year to avoid a disqualifying disposition?

Answer

Yes, you also need to hold the shares more than one year after exercise to avoid a disqualifying disposition.

Tell the CPAs who told you otherwise to see Internal Revenue Code Section 422(a)(1). It's pretty clear.

Question

Am I correct that if the stock splits (2:1) after an ISO is exercised, you must take that in account when selling the stock, so the grant price would then be one-half of the original grant price?

Answer

Yes.

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

We do not provide free technical support for TurboTax!

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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 starting a newsletter devoted to real estate tax issues - Michael Gray, CPA's Real Estate Tax Letter. Like this newsletter, we will talk about new developments, have reports on special tax concerns, and answer questions and answers. The subscription rate is $19.95 per month. For a sample issue, visit realestatetaxletter.com.

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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.

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 www.amazon.com or www.barnesandnoble.com or buy it at Stacey’s Books.)

P.S.

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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