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How To Avoid Costly Tax Return Mistakes: myStockOptions.com Newsletter No. 41


IN THIS ISSUE

How to avoid common tax-return mistakes with stock compensation
Articles on tax-return topics
Podcast and presentation on tax returns
Selected updates in tax-related content
Survey on companies' expected stock grant changes in 2010

A STITCH IN TIME: AVOID TAX-RETURN ERRORS NOW TO PREVENT COSTLY IRS PENALTIES LATER

At myStockOptions.com, we make the financial, tax, and legal planning for stock compensation easily understandable to people who don't want to read the Internal Revenue Code or the securities laws. This mission is never more valuable than during the pressures of tax-return season. The timely avoidance of errors on tax returns now can make a huge difference later, as mistakes can lead to costly IRS penalties, or even the dreaded prospect of an IRS audit.

Below in this newsletter is an FAQ that exemplifies the many ways in which myStockOptions.com can help you avoid expensive errors on tax returns that involve stock compensation. Elsewhere in the newsletter we also point you to our special articles on tax-return topics and a batch of new or newly revised content related to tax returns.

We appreciate your interest in myStockOptions.com. If you do not yet subscribe to Premium or Pro Membership, giving full access to our content and tools, please contact us before April 1 to receive a $25 discount on a one-year subscription. All of our content and tools are also available for licensing. We'd love to hear from you by phone (617-734-1979) or by email (editors@mystockoptions.com). Thank you.

—Matt Simon, Editor & Content-Manager


SPONSORS OF THIS ISSUE

Think Twice insider trading prevention videos: educate, entertain, and jolt your employees and executives (see the Think Twice website and information below)

Find out why E*TRADE Corporate Services is the stock plan provider of choice for a quarter of the S&P 500 (see E*Trade Corporate Services and information below)

Equity Focus: Not yet ready to move to an online equity management system? Download FREE Black-Scholes calculators to make FAS 123R reporting (now ASC Topic 718) easier and faster (see Equity Focus at Two Step Software and information below)


AVOID COMMON TAX-RETURN MISTAKES

Below are excerpts of FAQs about tax returns. The content is taken from the 750+ FAQs on myStockOptions.com. All of our content is available for your company to license or by Premium or Pro Membership. Please do not copy or excerpt our editorial content without our permission.

What are the biggest tax-return mistakes to avoid with stock options, restricted stock, and ESPPs?

1. Thinking you do not need to report sales. With a cashless exercise/same-day sale of stock options, the spread is reported on your W-2 and on your tax return as ordinary income. Even though you never owned the stock after exercise, you still need to report this transaction on Schedule D (Capital Gains and Losses) of IRS Form 1040. You may even have some small gains or losses, depending on how your company calculates the spread at exercise, and on any commissions and fees for the stock sale. For an annotated example of how to report the cashless exercise on your Schedule D, see another FAQ. A different FAQ explains and illustrates the reporting in a sell-to-cover exercise.

If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but without a corresponding report of the sale on your Schedule D, it would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.

The same applies with restricted stock and with an employee stock purchase plan. After selling any shares at vesting or at purchase, you still need to report the sale on Schedule D even though you have no gain and are also including it as part of your compensation income.

2. Paying more tax than you need to. With nonqualified stock options, the spread at exercise was already reported to the IRS on Form W-2 (or on Form 1099-MISC if you are a nonemployee) and is included in your income for the year of exercise. (With incentive stock options, if you make a disqualifying disposition, such as an early sale, the income will also appear on the W-2.)

Therefore, when you report the sale on Schedule D, do not make the exercise price your cost basis. Avoid double taxation by listing the market price on the date of exercise as your cost basis in the stock, which will be the exercise price plus the amount of ordinary income you already paid taxes on. For an annotated example showing how to report the sale on your Schedule D, see another FAQ on myStockOptions.com. With an ESPP, you can make the same mistake: be sure to include not just the discounted purchase price in your tax basis but also the W-2 income caused by the sale.

With restricted stock, a similar error lies in wait for the unwary. Your tax basis for reporting the stock sale on Schedule D is the amount of compensation income at vesting that appeared on your W-2. If you made a Section 83(b) election (not available for RSUs), the basis amount is the value at grant on your W-2. Do not assume that, because you did not pay any money to purchase the stock or exercise anything, your tax basis is zero. Otherwise, you will pay double tax on the value of the shares at vesting. See a related FAQ with an annotated diagram of Schedule D that shows how you report stock sales after you have held the stock at vesting.

See other FAQs on myStockOptions.com to read about many more tax-return mistakes to avoid with stock options, restricted stock, stock appreciation rights, and employee stock purchase plans.

Insider Trading Prevention And Education:
Think Twice Video And Intranet Series
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For more information on the Think Twice video series, and a free white paper on insider trading prevention and education, see http://www.insidertradingvideos.com. Both DVD and VHS formats are available. Qualified corporate buyers, including new IPO companies, can request free previews. Intranet licensing is available.

PREVENTING TAX-RETURN MISTAKES: PODCAST & PRESENTATION

myStockOptions.com offers entertaining podcasts on a variety of topics in equity compensation. Listen either through your web browser or on the go with a portable media player. The podcast of the moment is, of course, about tax-return tips and avoiding errors. Learn how to avoid costly mistakes that can attract unwanted IRS attention!

Along with our many articles on these topics, we just published a PowerPoint presentation (in PDF) entitled Tax Return Mistakes & Error Prevention, available in the Tax Center. Adapted from a webinar given by the editor-in-chief of myStockOptions.com, the presentation covers the top 10 most common tax-return blunders and questions related to stock compensation, whether options, restricted stock, or ESPPs. The coverage includes a discussion of 2009 and 2010 tax-law changes that affect tax returns and planning. Upon request, Premium and Pro Members of myStockOptions.com can obtain permission to distribute the presentation to employees or clients or to modify it for their own use.

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ARTICLES ON TAX RETURNS & RELATED TOPICS

Avoid Tax Return Mistakes With Stock Options & ESPPs: What You Need To Know In 2010
Puzzled by your W-2 or a 1099-B? Don't know how and where to report sales of company stock on your tax return? Learn simple tips to avoid errors that could prove costly later! (This article is available free!)

Restricted Stock & RSUs: What You Must Know To Avoid Tax Return Mistakes In 2010
Restricted stock or restricted stock units (RSUs), whether granted along with or instead of stock options, bring their own special issues to your tax return.

NQSOs: Tax Return Tips And Traps
Whether you complete your own tax return or just want to review what your tax preparer did, it's important to understand basic reporting requirements for nonqualified stock options. Learn what you need to report on your tax return at each stage of the NQSO life cycle.

ISOs: Tax Return Tips And Traps
Incentive stock options bring special complexities to tax returns, especially when the alternative minimum tax is involved.

How To Report Sales Of Company Stock
Learn how to report your sales of company stock on Schedule D of IRS Form 1040. Our comprehensive guide to Schedule D reporting covers sales of stock from nonqualified stock options, incentive stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, and stock appreciation rights.

About E*TRADE Corporate Services
With over 25 years of experience, 25% of the S&P relies on E*TRADE Corporate Services for innovative, end-to-end equity compensation solutions that offer ease, choice and the flexibility to adapt to your company's unique needs. The powerful combination of E*TRADE Corporate Services and E*TRADE Securities allows us to provide stock plan administration services from six global service centers for over 1 million participants in more than 160 countries worldwide.

HIGHLIGHTS OF NEW TAX CONTENT

Exercising NQSOs or ISOs while selling just enough shares to cover costs and taxes brings its own special twist to tax returns. For details on the reporting for these sell-to-cover exercises, see the FAQ on myStockOptions.com.

At some companies, international assignments are often accompanied by a tax-equalization package in which the company shields you from higher taxes abroad by agreeing to hold you in the tax position you normally have at home. Sounds nice, but how does it work? The relevant FAQ explains. Other international tax information is available in the Global Tax Guide at myStockOptions.com.

An unforeseen complication lurks in the Making Work Pay Credit, enacted in 2009 as a tax cut for 2009 and 2010. The credit is factored into your regular salary withholding, but if an income spike from stock compensation pushes you out of the credit's eligibility range, you may end up actually having to pay extra taxes on the credit with your tax return. Read more about this potential headache in the related FAQ.

Can the IRS seize stock options or restricted stock under a tax lien? Find out in a new FAQ at myStockOptions.com.

Two Step Software Two Step Software

Equity Focus at Two Step Software

Not yet ready to move to an online equity management system? Download these FREE Black-Scholes calculators to make your FAS 123R reporting (now ASC Topic 718) easier and faster.

STUDY SHOWS EXPECTED CHANGES IN 2010 FOR STOCK GRANTS

In a survey of global equity incentives, PricewaterhouseCoopers found numerous changes that the economic downturn has prompted beyond just programs to deal with underwater stock options (see Leading The Rebound: Equity Compensation In The Spotlight). PwC noted that the change most frequently mentioned by the surveyed companies is the replacement of service-based grants with grants based on performance conditions.

Companies were asked what changes they will make to grant practices in the upcoming year (2010) according to current market conditions.

Outlook for changes Percent of companies
Changes are ahead, but still exploring alternatives 45%
More performance-based restricted stock/RSUs 27%
More service-based restricted stock/RSUs 15%
Relaunch of ESPP (with or without redesign) 12%
Cash or nonequity benefit instead of options 12%
More performance-based than service-based restricted stock/RSUs 8%

PwC found a continual decrease in time-based stock option grants since 2006, along with a move towards time- and performance-based restricted stock and RSUs. While its 2007 edition of the survey found an increase in performance-based grants, this trend "lost a little momentum" in 2009, when more companies used time-based grants of restricted stock/RSUs. Believing this to be a response to the uncertain economic conditions, the firm thinks it may be merely a "temporary reversal" in the trend toward more performance-based grants.

See myStockOptions.com for more survey data on changes in stock grants and ESPPs amid mandatory expensing, the economic downturn, and other current circumstances affecting stock compensation.

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