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Table of Contents

• Happy Easter and St. Patrick’s Day
• Only 31 days until April 15!
• Telephone seminar recording available
• Is this a good time to exercise an ISO?
• If you want your rebate check soon, file early
• Questions and Answers
• Is it better to receive a stock grant or option?
• My employer didn’t report my option income on my W-2!
• How do I report the sale of restricted stock?
• When is ISO income taxed as capital gains?
• Can I transfer my NQSOs to an LLC for favorable taxation?
• How can I get better tax treatment for a forced sale?
• Do you know about our other newsletters?
• IRS Circular 230 Disclosure
• Consult with a tax advisor
• Subscribe to Michael Gray, CPA's Option Alert!

Happy Easter and St. Patrick’s Day

Easter is early this year – March 23. St. Patrick’s Day is just the previous Monday – March 17.

We wish you the luck o’ the Irish and a very happy family celebration for Easter.

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Only 31 days until April 15!

We can still squeeze in a few more clients for preparing income tax returns, although we’ll be preparing extensions for many who submit their information after March 15.

If you need to meet us in person, there are a few appointment times open. Call Dawn Siemer now at 408-918-3162 (weekday afternoons) to make your reservation.

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Telephone seminar recording available

If you weren’t able to participate in our telephone seminar on February 29, you can still "listen in".

We have a CD recording available. An order form is attached.

Please send your request no later than March 31, 2008 or call Dawn Siemer at 408-918-3162.

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Is this a good time to exercise an ISO?

If you have read our free report, Executive Tax Planning For Incentive Stock Options, you know that I generally favor a simultaneous exercise and sale of ISO stock. However, there are scenarios when many taxpayers decide to hold the stock after an exercise.

When you do exercise an ISO and hold the stock, it is often advantageous to exercise early in the year (say before March 31).

First, if the option was granted more than one year before it was exercised, the only test that remains to be passed is for the stock to be held more than one year after exercise. You might be able to sell the stock just before April 15 of the year after exercise, make a qualifying disposition to avoid regular tax ordinary income and get the cash to pay the tax.

Second, if you had a low tax base for 2007, you might still be able to avoid penalties for underpayment of estimated tax.

Third, stock market prices are generally low this year (2008), which should reduce the amount of AMT income to be reported for the exercise.

Fourth, for risk management, the "escape hatch" should be available. If the value of the stock falls before the end of the year of exercise and you sell the stock before the end of the year, ordinary income will be computed as the excess of the sale price over the option price and the AMT income adjustment will be eliminated. Remember, you have to avoid buying replacement shares or even receiving an option during the period 30 days before to 30 days after the sale to avoid the "wash sale" rule that would disqualify you from using the "escape hatch".

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If you want your rebate check soon, file early

Most of the readers of this newsletter won’t qualify for a federal tax rebate, because their income is too high. If you do qualify, remember the IRS must receive your income tax return before processing your rebate check. If you want to receive your rebate check soon, don’t extend the filing date of your 2007 income tax return. File as early as possible.

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Questions and Answers

Question

I am a senior executive in a small company. I negotiated to receive 10% equity in the company.

The owner says there is no way he can make a stock grant to me without my incurring a big tax. He suggested that I accept a stock option, instead.

I would rather own the stock and might be willing to borrow the money to pay the taxes.

What do you think?

Answer

I think that it usually isn’t wise to incur a significant cash investment (of taxes) for illiquid stock. It sounds like this is a closely held company and there is no market for the stock. Unless you expect a "liquidity event" in the foreseeable future, a stock grant probably isn’t a good choice.

Before you make your decision, see if you can find out what the stock valuation would be. A study should be done whether the grant is of stock or an option. If the value is small, there is little risk in going ahead with the grant. Note that the value of minority interests in closely held stock should be discounted significantly. (Say at least 30%.)

If you receive an option, you could eventually have to get the cash to pay for it. Perhaps the company could give you a cash bonus to pay for it.

Question

I left my former employer last year. At the time I left, I exercised some NSOs and kept the shares. The option price was $0.04 and the fair market value on the exercise date was $0.25. It appears to me that my former employer didn’t include the income on my W-2.

Where do I report the income on my income tax return?

Answer

First, you ask your former employer to reissue your W-2.

If it refuses, I suggest that you report the income as "other income" on line 21 of Form 1040.

Some tax return preparation software includes the income as an adjustment to Wages on line 7. That works, too.

Question

1. How do you report the sale of restricted stock units? Are they reported on Schedule D like other stock sales?



2. If you receive a 1099-MISC from a company for whom you performed consulting services relating to exercising a non- qualified stock option, should the income be reported on Schedule C?



3. If you didn’t sell the stock received from exercising the NQO (during 2007) until the next year (2008), how do you avoid being taxed again on the gain from the sale?

Answer

1. Yes. (Ordinary income should have been reported when the restricted stock grant was received or when the shares vested. This establishes the tax basis (cost) of the shares for Schedule D.)



2. Yes.



3. The tax basis (cost) of the shares reported on Schedule D for 2008 should be the option price plus the ordinary income relating to the exercise of the option that was taxable for 2007.

Question

ISO granted March 15, 2001, vested on March 15, 2002 and exercised and sold stock on October 12, 2007. I received an option disposition statement from my employer that says, "Exercise date 10/12/07, Grant date 3/15/01, and sale date 10/12/07." Is this ISO still qualified so capital gains will be reported on Schedule D?

Answer

The second test for a qualified disposition is the stock must be held more than one year after the exercise date. You didn’t meet this test. Your employer should have already included the income from the disqualifying disposition on your Form W-2.

If you received a Form 1099-B relating to the sale of the stock, report the sale price on Schedule D. For the tax basis (cost) of the shares, report the option price plus the income reported on Form W-2. This should result in zero income or a very small loss for selling expenses.

Question

I wish to use non-qualified stock options that I own to fund an LLC business. Is it possible to transfer the stock option ownership to my LLC for favorable taxation so that, when it is sold, the gain is taxed at the corporate rate?

Answer

Usually LLCs are not taxed as corporations. When the LLC is owned by a single member, it is disregarded for income tax reporting and income of the LLC is reported on the income tax return of the member.

LLCs may elect to be taxed as corporations.

The IRS eliminated what was perceived to be a loophole that stops ordinary income to the optionee when the option is sold or otherwise disposed to a person or entity related to the employee or service provider on or after July 2, 2003. (Treasury Regulations Section 1.83-7.)

This means that when the "corporate" LLC exercises the non- qualified stock option, the income will be taxable to you.

Further, the sale of a NQO to a related person for a consideration that includes a deferred payment of money or property is a listed transaction, requiring special disclosure on an income tax return. (Treasury Notice 2003-47, 2003-2 C.B. 132.)

Needless to say, this is not a good strategy.

Question

My company was sold last fall. I owned stock and had outstanding options at the time of the sale. It was a cash deal for all the existing stock and options. On the date of sale, all stockholders sold their shares or had their options purchased. The sale terms include a delayed payment schedule that extends to the first and second anniversary of the closing date. We received 60% at closing plus 20% plus interest on the next two anniversaries.

Can I delay claiming the sale of some of the stock and options until the first or second anniversary so that I can claim the gains as long-term instead of short term?

Answer

If your company was not publicly traded, the sale of stock might qualify for installment sale reporting. Your holding period for the stock will not change from short term to long term. The sale should be reported on Form 6252.

There is a question whether taxation is deferred for ordinary income for buying out your options until you receive the payments. These amounts should be reported on your W-2 form from the successor company. Most of my clients’ employers are postponing showing the income until it’s paid. I wish somebody would apply for a ruling on this issue. Any volunteers?

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

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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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Secrets of Tax Planning For Employee Stock Options Recording Order Form

Yes! Please send me a recording of your "Secrets of Tax Planning For Employee Stock Options" telephone conference. I want to learn how to get the maximum tax benefits from my options under the new tax laws while avoiding expensive tax traps.

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or mail to Michael Gray, CPA
2190 Stokes St., Ste. 102
San Jose, CA 95128-4512
© 2008 Michael C. Gray

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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.)

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