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Table of Contents

• Senator Levin seeks deduction limit for stock options
• Report of Foreign Bank and Financial Accounts is due July 2
• The year's half over. How's it going?
• Pre-release offer for our new book
• Live employee stock option seminar on August 16
• Employee stock option telephone seminar on August 15
• Michael Gray speaks on non-qualified compensation plans
• More guidance coming for Section 409A
• AMT report prepared for Senate Finance Committee
• Questions and Answers
• How do I sell ESOP stock?
• How much should I have withheld for my option exercise?
• Do you know about our other newsletters?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert

Senator Levin seeks deduction limit for stock options

Senator Levin, who is the Chairman of the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations, is considering re-introducing legislation to limit the corporate tax deduction for exercise of employee stock options to the amount expensed for granting the options on the employer's financial statements. According to Senator Levin, in 2004, companies deducted $43 billion more in stock option expenses than the amount reported on their financial statements.

This problem arises from the disparity in accounting for stock options for financial reporting versus tax reporting. For financial reporting, an estimated value of the options is expensed at the time they are granted. For tax reporting, the expense is reported when a non-qualified option is exercised or the stock becomes vested, or when there is a disqualifying disposition of ISO or ESPP stock.

An important piece of this puzzle that Senator Levin did not discuss is the symmetry of income reported by the employee for income tax purposes. In other words, the corporation receives a tax deduction for the same amount the employee reports as income.

Also, the timing element is critical. If the tax law for corporate deductions is conformed to the financial reporting rules, then employees should at least be able to elect to have their options taxed at the time they are granted, based on the same valuation the corporation uses for financial reporting. (This election isn't available right now.) Any additional appreciation of the option or the underlying stock should then qualify to be taxed as a capital gain, and a loss of value after election should be deductible as a capital loss when the option expires. However, the loss of tax deferral would substantially decrease the value of employee options to employees.

If Senator Levin's proposal is accepted, it will be another nail in the coffin of employee stock options. Do we want to have them or not? Employee stock options have been a tremendous way for employees to translate brain power into wealth, and for employees to participate in the American Dream. Should we be so anxious to destroy this valuable employee benefit?

Do we really want to put stock option advisors out of business?!

Nuts.

Write your representatives in Congress to let them know what you think.

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Report of Foreign Bank and Financial Accounts is due July 2

Form TD F 90-22.1, the Report of Foreign Bank and Financial Accounts for 2006 is due July 2. The form is required when a U.S. person has a financial interest in, signature or other authority over any financial accounts in a foreign country when the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year. Taxpayers who have filed an extension for their 2006 income tax returns should be especially mindful of this deadline.

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The year's half over. How's it going?

If you're like me, the first six months of this year has been a blur. Some of my plans had to be put on the back burner with tax season, Dawn's maternity leave, Kara's arrival, and moving our office.

How have your plans been working out? Consider scheduling an appointment for a mid-year tax planning "check up". Call Dawn Siemer weekday afternoons at 408-918-3162 to make your appointment.

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Prerelease offer for Secrets Of Tax Planning For Employee Stock Options

I will soon be releasing the second edition of Secrets Of Tax Planning For Employee Stock Options. If you would like information about the book, including a half-price pre-release offer, visit our new website, Employee Stock Option Secrets.

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Live employee stock option seminar on August 16

Michael Gray will be presenting a live seminar, Secrets of Tax Planning for Employee Stock Options at Hobee's Restaurant in Campbell, California from noon to 2 p.m. on Thursday, August 16. Space will be limited to 35 participants. Lunch will be included. Call Dawn Siemer at (408) 918-3162 or email mgray@stockoptionadvisors.com for details.

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Employee stock option telephone seminar on August 15

Michael Gray will presenting a telephone seminar, Secrets of Tax Planning for Employee Stock Options, on Wednesday, August 15 from 1 - 2:30 p.m. Pacific Time. Call Dawn Siemer at (408) 918-3162 or email mgray@stockoptionadvisors.com for details.

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Michael Gray speaks on non-qualified deferred compensation plans

Michael Gray, CPA and attorney Michael Brayton will discuss the final regulations under Internal Revenue Code Section 409A, Non- Qualified Deferred Compensation Plans, at two presentations. One will be a breakfast meeting for the Silicon Valley San Jose Chapter, California Society of CPAs on July 18 from 8:30 a.m. to 11:30 a.m. at the Los Gatos Lodge. For details, call Stephanie Stewart at 408-983-1122. The second will be a lunch meeting for the Santa Clara County Bar Association on July 25 from noon to 2 p.m. at the Bar office 31 N 2nd Street, 4th floor in San Jose. For details, call Cindy Gartner at 408-975-2113.

These regulations have a surprisingly broad application, and the penalties for violating these rules are severe. Some items we'll be talking about include pricing employee stock options, waiver of salary for small business owners, split dollar life insurance and expense reimbursement arrangements, in addition to structuring traditional non-qualified deferred compensation arrangements.

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More guidance coming for Section 409A

Steven Tackney, who is IRS Chief Counsel attorney, Tax Exempt and Government Entities Division, has indicated the IRS will be issuing more guidance under Section 409A, the non-qualified deferred compensation rules. He was speaking at the Federal Bar Association's 19th Annual Insurance Tax Seminar on June 1.

The guidance should include instructions for reporting the deferrals on Form W-2, and the measurement of compensation to be reported. Some new rules adopted for foreign trusts in the Pension Protection Act of 2007 also need to be explained.

Tackney does not expect the IRS to issue model plans or to make letter rulings blessing plans. The IRS knows it would be swamped if such procedures were adopted.

Proposed regulations could be issued by fall, 2007.

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AMT report prepared for Senate Finance Committee

The Joint Committee on Taxation has issued a background report relating to the individual alternative minimum tax. The report highlights the growing number of taxpayers subject to the tax, and what the tax revenue results would be if certain changes were made. More taxpayers are becoming subject to the tax because the level of income exempt from the tax is not indexed for inflation and because the Bush tax cuts have reduced regular tax rates, but not AMT tax rates, except for long-term capital gains and qualified dividends. When the Bush tax cuts expire after 2010, there will be a dramatic drop in the number of individuals subject to the AMT. You can get a copy of the report at www.house.gov/jct/x-38-07.pdf.

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Questions and Answers

Question

How do I go about selling stock from an ESOP of my former employer, so I can buy other investments?

Answer

This is a very complex question for which you really should meet with a tax consultant. (That is our business!) Handling retirement plan distributions is loaded with tax traps and financial planning considerations.

The starting place for information is the Summary Plan Description that you should have received from your employer, and the person who is responsible for administering the plan. The plan should tell you when distributions must be made after termination.

Based on your question, I am assuming the employer stock is not publicly traded. In that case, employee participants must have a "put" option, which is an option to sell the stock to the employer, under a fair valuation formula. The period during which the distributee may exercise the option is from the date following the date of distribution to the date 60 days thereafter. If the option isn't exercised during that period, the employer must provide another option to exercise during a 60- day period in the following plan year.

The option may provide for payment for the stock in substantially equal periodic payments (at least annually) over a period of up to five years, and that arrangement must be adequately secured.

This is just some basic information to help you get started. Please make that consultation appointment.

Question

Last year when I sold company options, not enough taxes were withheld and I had to write a big check to the IRS in April. When I asked how to avoid this, I was told to alert my company on the day I plan to exercise and tell them what percentage I wish to be taken out.

I know the percentage withheld for my exercise in 2006 was 25%. Should I tell them to withhold 35% for 2007, or perhaps an even higher amount?

The company was also unable to tell me the default withholding rate for my state, Georgia. Where can I find this information?

Answer

I found a 2007 employer withholding booklet at the Georgia Department of Revenue web site. On page 13, it says the withholding rate for bonuses and other compensation. It shows a sliding scale of withholding, with 6% applying when the annual income exceeds $15,000. The maximum Georgia state income tax rate for individuals is 6%, and it applies at a very low taxable income threshold.

I don't have enough information to answer your question about what rate of tax to withhold for federal tax for the option exercise. 35% is probably fairly "safe", but you can get a better answer by making a tax projection. A tax consultant can help you with this. It's one of our tax planning services.

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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 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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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.