Recommend Our Site to Your Friends!

Print This Page

Table of Contents

• Tax season is here!
• Yes, we do prepare income tax returns!
• Deduction allowed for corporate payments for ESOP redemption
• Questions and Answers
• How does the $100,000 per year ISO limit work?
• How will my ISO buyout be taxed?
• Do you know about our other newsletters?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert!

Tax season is here! Make your appointment now!

There are only about two and one-half months left before the tax return due date. Time to get started now!

If we prepared your income tax returns last year, you should have already received instructions in the mail. If you haven't, please call Dawn Siemer at 408-918-3162.

To have us prepare your income tax returns, start with the online Tax Notebook organizer. Call Dawn Siemer at 408-918-3162 for instructions to get started. We also have a paper organizer if you prefer. We still need your documents (W-2s, 1099s, receipts for donations) to prepare your income tax returns.

We can prepare most income tax returns using information provided online and by mail. If you wish a personal meeting, please call Dawn Siemer at 408-918-3162 to schedule an appointment. Our calendar is filling up fast!

Return to Table of Contents

Yes, we do prepare income tax returns!

With our free newsletters and the information we make available at no charge on the web, some people wonder how we make a living. We prepare income tax returns and provide tax and business consulting services. We are accepting selected new clients and are thrilled when our clients and friends refer their friends, associates and family members to us. To inquire about becoming a client of our firm, please call Dawn Siemer at 408-918-3162 or send an email to her at mgray@taxtrimmers.com. We must receive your tax information by March 1 to guarantee delivery by April 15.

Return to Table of Contents

Deduction allowed for corporate payments for redemption of ESOP stock

A U.S. District Court has granted a summary judgment in favor of General Mills, Inc., which claimed tax deductions for redemptions of stock for retiring employees under the corporate ESOP plan.

The court agreed with General Mills that the redemptive dividend payments are deductible as dividends when paid to an ESOP under Internal Revenue Code Section 404(k). The IRS and General Mills stipulated the payments were essentially equivalent to dividends.

The IRS argued that the deduction should be disallowed because, under Internal Revenue Code Section 162(k), "no deduction otherwise allowable shall be allowed... for any amount paid or incurred by a corporation in connection with the redemption of its stock."

The court found the legislative history for this provision indicates it should be narrowly construed to disallow deductions for fees and other expenditures necessary and incident to repurchase which would otherwise be deductible business expenses, citing Boise Cascade Corp., 329 F. 3d at 758.

The IRS also argued that the deduction would be disallowed under Revenue Ruling 2001-6, because Section 404(k)(5)(A) says the "Secretary" (of the Treasury) may disallow the deduction if the Secretary determines the dividend constitutes an evasion of taxation.

The court agreed with General Mills that there was no indication that the Secretary of the Treasury delegated authority to the IRS Chief Counsel for this Revenue Ruling. (This part of the ruling was based on a stipulation of the IRS and General Mills that there was no delegation of authority.)

If the IRS decides to appeal this case or contest similar cases, it might rethink the stipulations it will accept.

I wonder if the conclusion expresses the intent of Congress, considering General Mills already received a tax deduction for the ESOP's purchase of the stock. From a tax policy standpoint, why should General Mills get a tax deduction for redeeming the stock? The IRS could also go to Congress to request a technical correction for this "loophole".

(General Mills, Inc. v. United States, (DC MN 1/14/2008), 101 AFTR 2d 2008-381.)

Return to Table of Contents

Questions and Answers

Question

I'm confused about how the $100,000 per year limit for ISOs works. (If more than $100,000 of ISOs are first exercisable in a taxable year, any excess of options issued over the limit are reclassified to NQOs.) What's the interplay between the value on the grant date and when the stock becomes exercisable?

Answer

The value of stock in determining the limit is based on the fair market value on the grant date. The option price for most ISOs is the fair market value on the grant date, so that can be a "short hand" way of determining whether the limit applies.

The dollar limit applies based on when the options are exercisable. Most ISOs become exercisable as they vest, but some have an early exercise privilege.

For example, the ISOs for XYZ Company become exercisable as they vest. They vest 25% per year. In year 1, an ISO is granted to Jane Employee for 100,000 shares at 50¢ per share, the fair market value when the ISO is granted. In year 2, another ISO is granted to Jane for 200,000 shares at $1 per share, also fair market value on the grant date. These are the only ISOs granted. In year 3, $62,500 is first exercisable for the $100,000 limit. (100,000 X 50¢ = $50,000 X 25% = $12,500 for ISOs granted in Year 1; 200,000 X $1 = $200,000 X 25% = $50,000 for Year 2.)

You have to look at the terms of the plan and whether vesting has later been accelerated to determine if there is a problem.

Question

My company is being sold in an all-cash buyout. All of my incentive stock options will vest. I will be forced to sell the stock. Since I will be forced to sell, are the profits from the sale taxed at the capital gains rate or as straight income?

Answer

Assuming the transaction is an exercise and sale (or just a settlement of the value of the options), all of the income will be taxable as ordinary income. Employee stock options aren't capital assets and you will not meet the holding period requirements for the stock to qualify for long-term capital gains or to avoid having a disqualifying disposition.

---

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

Return to Table of Contents

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.

Return to Table of Contents

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.

Return to Table of Contents

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.

Return to Table of Contents

(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.)

Subscribe to Michael Gray, CPA's Option Alert!

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.