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Table of Contents

• Third quarter estimated tax payment is due 9/17
• Tax Court disallows AMT NOL relating to ISO stock
• IRS gives more time for deferred compensation plan updates
• How to allocate compensation from nonqualified stock options
• Questions and Answers
• How should I fill out my tax forms for NQSO stock?
• Will exercising NQSOs impact my social security benefits?
• Can I get a refund for an un-filed election?
• Do I have employee stock options?
• 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 payment is due September 17

Remember the third quarter estimated tax payment for calendar-year taxpayers, including most individuals and trusts, is September 17.

If you have had a change in circumstances, such as a major capital gain, exercising stock options, or an early disposition of stock options during June, July or August, you should contact your tax advisor to determine whether any change in estimated tax is required.

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Tax Court disallows AMT NOL relating to ISO stock (again)

The Tax Court ruled in favor of the IRS that an alternative minimum tax (AMT) net operating loss (NOL) will not result when ISO stock is sold at a loss because of basis adjustments reported on the alternative minimum tax schedule when an ISO is exercised.

The taxpayers suffered a severe decline in the value of Veritas stock received from the exercise of an ISO during 2000 when the stock was sold during 2001.

The taxpayers unsuccessfully tried to apply a principle that applies to depreciation adjustments for business income to the loss from ISO stock. The Tax Court rejected the argument.

(Marcus v. Commissioner, 129 T.C. No. 4, 8/15/2007.)

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IRS gives more time for deferred compensation plan updates

The IRS has announced that the deadline for taxpayers to update their nonqualified deferred compensation documents to comply with the final regulations under Internal Revenue Code Section 409A has been extended from December 31, 2007 to December 31, 2008. (Some agreements for nonqualified stock options may be eligible for this extension.) The January 1, 2008 effective date of the final regulations has not been extended, so the plan must be operated in conformity with the final regulations in order to qualify for the extension of time to complete the documents.

This extension was given in response to an outcry from the legal community that there wasn’t enough time to update all of the plans by December 31, 2007 considering the IRS issued the final regulations on April 17, 2007.

(Notice 2007-78, I.R.B. 2007-41, 9/10/2007.)

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How to allocate compensation from nonqualified stock options

When taxpayers move or work in several states, it can be puzzling to determine how much of the income realized when a non-qualified stock option is exercised is taxable in the various states.

The California Franchise Tax Board says in Publication 1004 to allocate the ordinary income based on the number of days worked from the grant date to the date of exercise.

New York’s Department of Taxation and Finance also prescribed this method. A taxpayer recently successfully challenged that position before the New York Tax Appeals Tribunal. The taxpayer used the number of days worked solely in the year of exercise. (State of New York Tax Appeals Tribunal, In the Matter of E. Randall Stuckless (8/17/2006) DTA No. 819319.)

The New York Department of Taxation and Finance still says taxpayers should use the days worked from the grant date to the exercise date for tax years before January 1, 2006 when the employee exercised the option after termination.

New regulations have been issued for New York requiring nonresidents to allocate stock option income based on workdays from the grant date to the vesting date. (20 NYCRR §§ 132.24, 132.25.)

The IRS’s method of allocating income earned inside and outside the United States from non-qualified stock options is based on the dates from the grant date to the vesting date. (Treasury Regulations § 1.861-4(b)(ii)(F).

Double-taxation can result when the states are inconsistent in the methods they apply to allocate income of nonresidents from the exercise of non-qualified stock options.

There is a good article exploring this topic in the August 1, 2007 issue of Spidell’s California Taxletter.

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Questions and Answers

Question

I’m a new subscriber with a question about Schedule D for the sale of NQSO stock.

Date acquired – 8/22/02; date sold 4/28/05.

Sale price $38,000; cost - $20,000; Gain - $18,000.

The $18,000 gain was reported on Form W-2. I received a 1099-B for the $38,000 sales price. How do I avoid also reporting the gain again on Schedule D?

Answer

I take it the "date acquired" is the grant date for the option, and that you exercised the option and sold the stock on 4/28/05.

Looks like you’re behind in filing your income tax return. I highly recommend that you keep current to avoid late filing penalties.

Since you have reported taxable income of $18,000 as part of your W-2 wages, you get to add that amount to the grant price of $20,000 for a total tax basis (cost for determining gain or loss on sale) of $38,000. Therefore, the gain reported on Schedule D would be zero. You might actually have a small loss for transaction costs subtracted from the sales proceeds reported on Form 1099B.

You could have found this information by searching our site, or by reading our free report, Non-Qualified Stock Options – Executive Tax And Financial Planning Strategies.

Question

I received NQSOs for 2100 shares from my employer at an average price of $13. I retired a year ago at age 63, and am now receiving social security. I have 3 years to exercise the options or they will lapse. The excess of the fair market value of the shares over the option price is $56,000.

Is this gain ordinary income subject to regular income, social security and Medicare taxes rather than a capital gain? If this is so, should I delay exercising the options until after I am age 65 so the income will not impact my social security benefits?

Answer

Yes, the income will be taxed as wages, subject to income and employment taxes.

I am not an expert on social security benefits. My understanding is that the option income is considered a separate category of "deferred compensation" income that should not reduce your benefits. I suggest that you consult with a social security case worker about that issue.

Question

I was awarded a tax bonus due to a Section 83(b) election that I never filed with the IRS. Is it possible to receive a refund for the taxes paid due to an un-filed election?

Answer

Yes. You have created a mess. If the income was reported on a Form W-2, you should start by getting a corrected Form W-2 from your employer. This is not the way to win a popularity contest. Good luck.

Question

I joined a private company and received this offer:

"On your first day of work, you will be granted non-qualified stock options to buy shares of company common stock priced at $ .75. This grant will vest as follows: one-fourth (25%) of the options on the first anniversary of your employment commencement date, and the remaining seventy five percent monthly over the next three years at the rate of 1/48 per month, such that the option shall become fully (100%) vested on the fourth anniversary of your employment commencement date. Grants are subject to the terms of the Company Stock Option Plan."

I want to know what this means. I have no clue. Does this mean I have a stock option from the company or not? Is this beneficial to me or not?

Answer

Yes, it appears you have received a stock option from your company. "Vesting" means when you receive the shares, you have full ownership rights in them. Since the company stock is not publicly traded, I suggest that you should handle the options very carefully. Ask who in the company is responsible for administering the employee stock option plan, meet with that person and ask him or her to explain how the plan works to you.

Get a copy of our free report on non-qualified stock options.

Consider studying a book about employee stock options. We have a new one, Secrets of Tax Planning For Employee Stock Options, Stock Grants and ESOPs.

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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.