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Table of Contents

• Tax planning season is here
• May vacations
• Do you have a big AMT credit carryover?
• Casualty and theft loss denied WorldCom employee
• Questions and Answers
• Can I recover taxes I paid in a prior year?
• Can worthless NQSOs be used for a tax benefit?
• How do I report gains on my stock option 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

Tax filing season is over. Tax planning season is here. How can we be of service to you?

With April 15 behind us, we have been focusing on finishing extended income tax returns. Now we have time to think about tax planning issues. How about discussing putting your estate plan in place, or updating an old plan? Do you have a stock option exercise to prepare for? I have been talking to several people who are arranging their affairs to get the refundable minimum tax credit. Thinking of starting a business or making changes to your existing business? Looking for profit improvement ideas? To make an appointment, please call Dawn Siemer weekday afternoons at 408-918-3162.

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May vacations

Thi Nguyen and her husband, Allen Le left May 1 for Waikiki, and she will return to the office on May 6. Aloha!

Mike and Janet Gray are leaving May 3 for Edisto and Charleston, South Carolina and he will return on May 12.

Dawn Siemer will be minding the firm and making appointment reservations weekday afternoons at 408-918-3162 in our absence.

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Do you have a big AMT credit carryover?

I have been meeting with a number of people with big federal minimum tax credit carryovers. Remember that there is a temporary provision making AMT credits that are more than three years old refundable.

See the explanation at "Refundable AMT Credit Available for 2007". (The refundable credit is also available for 2008.)

One person had a $900,000 credit carryover and decided to plan an early retirement!

To make an appointment to discuss whether you can use your minimum tax credit carryover, call Dawn Siemer weekday afternoons at 408-918-3162.

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Casualty & Theft Loss Denied To WorldCom Employee

In a small Tax Court case that can’t be cited as precedent, the Tax Court denied a casualty or theft deduction to Mehdi Taghados, a WorldCom employee. (Taghados represented himself before the Tax Court.)

Mr. Taghados worked at WorldCom for 17 years. On October 31, 2001, he exercised stock options to purchase WorldCom shares and held the shares after exercise. He also purchased shares through the company 401(k) plan and employee stock purchase plan, and on the open market.

WorldCom filed a chapter 11 bankruptcy petition on July 21, 2002. Bernard Ebbers, chief executive officer at WorldCom, was convicted of violating securities laws for fraud, conspiracy, and filing false financial statements with the Securities and Exchange Commission. Other WorldCom officials pled guilty to fraud and conspiracy.

On October 31, 2003, the bankruptcy court confirmed WorldCom’s plan of reorganization. Effective April 20, 2004, WorldCom’s plan of reorganization provided for the cancellation of junior interests, including Mr. Taghados’s stock.

Mr. Taghados received a brokerage account statement for the period ending March 28, 2004 that his stock had a value of 2.1¢ per share. On May 17, 2004, his broker issued a notification that his 31,083 shares were not longer transferable because WorldCom had closed its transfer books.

Mr. Taghados claimed a $1,344,863 deduction for a casualty or theft loss on his 2003 federal income tax return. The IRS denied the deduction.

The Tax Court found in favor of the IRS.

It cited Furer v. Commissioner, T.C. Memo. 1993-165, that "In order for a loss to qualify as a casualty loss, it must be the result of physical damage to the taxpayer’s property." The Tax Court said there was no physical damage to the petitioner’s securities, and the loss did not result from an event that was sudden, unexpected or from an unusual cause.

Principally citing Paine v. Commissioner, 63 T.C. 736, 740 (1975), the Court also found there was not a theft loss. A theft would have to be established under Virginia law. Mr. Taghados failed to establish the theft. It was WorldCom, not Mr. Taghados, that was the victim of the fraud. The victim status couldn’t be attributed to the shareholders.

Taghados couldn’t prove that he relied on misrepresentations when he bought the shares.

Although the issue of whether a capital loss could be claimed for worthless securities wasn’t raised by Taghados or the IRS, the Tax Court discussed the issue. The taxpayer had a brokerage statement indication the shares had some value on March 28, 2004. Possibly a loss could be claimed when the shares were cancelled on April 20, 2004. The year at issue in this case was 2003, so no worthless stock deduction would be allowed for that year.

This is a tough case. Mr. Taghados might have fared better if he had legal counsel, but he also might not.

Remember for worthless stock deductions that you will have an identifiable event if you sell the stock. Some brokerage companies will buy worthless stock for $1 as a service to their customers.

(T.C. Summary Opinion 2008-44.)

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Questions and Answers

Question

My employer split into 2 divisions at which time my options were also split. One division was sold and my options were converted to shares on which I paid taxes. I sold those shares last year at a loss. I understand my (capital) loss is limited to $3,000 per year and can be carried over.

Can I recover the taxes I paid in that prior year since the stock’s value when sold was lower?

Answer

No.

The only way I can think of that you could is if capital loss carrybacks were allowed for individuals, and they aren’t.

An idea is to establish that the value on the date that you converted the shares (exercised the option) was wrong. That would be very expensive and difficult to prove in light of the division sale.

You only have to look at listed values of shares on the stock market to know that values change all of the time. Tax results depend on values on transaction dates, not later events.

Question

Is there any scenario where worthless NQSOs could be used for some tax benefit where a loss can be claimed?

Answer

Since no income is reported when the options are received, they have no tax basis and no loss can be claimed for them when they expire worthless.

Question

I exercised NQSOs for 1,000 shares of company stock for $5.00 per share when the fair market value was $12.00 per share. Taxes were paid for $7,000 of income. After a few months, the shares were sold for $16.00 per share.

Do we pay taxes on $11,000 (($16 – 5) X 1,000) or $4,000 (($16 – 12) X 1,000)?

What forms should be used to report the sale?

Answer

There is a lot of information about this at our site and in the article on Executive Tax and Financial Planning For Non-Qualified Stock Options.

The $7,000 of ordinary income for the exercise of the NQOs should have already been included on your Form W-2.

That $7,000 is added to the $5,000 paid for the stock to compute a tax basis (cost for gain and loss reporting) of $12,000. The sale of the stock should be reported on Schedule D for a $4,000 short-term capital gain.

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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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(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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