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Tax Returns: myStockOptions.com Update No. 19
Tax-return season brings many of you to our Web site for articles and FAQs that help you understand tax rules, forms, and filing requirements. The 2003 tax cut makes this tax season even more challenging than usual for those of you with stock options, restricted stock, and/or ESPPs. Our Tax Center is popular.
Below is the full text of two FAQs on tax-return topics, along with links to other new content at myStockOptions.com. This is a small sample of the content that is available to Premium Members.
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myStockOptions.com has special updated and exclusive articles on tax-return topics:
NQSOs: Tax Return Tips And Traps
ISOs: Tax Return Tips And Traps
Avoid Costly Tax Return Mistakes And Maximize Your Profits: What Optionees Need To Know
Stock Option Financial Planning After Your Tax Return Is Filed (Part 1)
Below are two frequently asked questions (FAQs). They are taken from the 500+ FAQs on myStockOptions.com. All of these are available for your company to license or by Premium Membership.
What are the biggest stock-options-related mistakes I can make on my tax return, and how can I avoid them?
Some of the mishaps are:
1. With a cashless exercise/same-day sale you have ordinary income on the spread that is reported on your W-2. However, you still need to file the Schedule D used to report capital gains and losses on stock sales. Otherwise, the IRS will think you failed to report the gain on the sale. You may even have some small short-term gains or losses, depending on how your company calculates the spread at exercise and on any commissions and fees for the stock sale. Do this reporting for each separate cashless exercise when you had more than one, even though your W-2 will aggregate all the exercise gains.
2. With NQSOs, the spread at exercise was already reported to the IRS on Form W-2 (or on Form 1099 if you are a non-employee) and is included in your income for the year of exercise. Thus, 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 would be the exercise price plus the amount of ordinary income you already paid taxes on.
3. With ISOs, when you exercise and hold through the calendar year of exercise, remember that you need to complete an AMT return (Form 6251) to see whether you owe AMT. If the tax amount is higher than the ordinary income tax, you need to pay AMT. Your company does not send you a W-2 for this spread amount when you hold the ISO stock, so remember to do this.
4. When you have paid AMT because of your ISO exercise and hold, you get a tax credit. The rules now get even more complex. You do not need to sell the stock to start using this credit. But every year until the credit is used up, you do need to complete IRS Form 8801 to calculate it. Once you have sold the stock, avoid paying or calculating more AMT than is required for your ISO stock sale by reporting (as a negative amount) your "adjusted gain or loss" on Part I of IRS Form 6251. For details, see the relevant FAQs in the Tax Center on myStockOptions.com.
5. For shares you sold after May 5, remember that they qualify for the lower capital gains rates even if the options were granted or exercised earlier. What matters is that you hold them for more than 12 months. The 2003 Schedule D has a new column for reporting gains or losses that occurred after May 5.
I exercised NQSOs, held the stock, and now have long-term capital gains on the sale. Do I get any "credit" on my tax return for the income tax previously paid for the spread at exercise?
It's not like with ISOs when your exercise-and-hold triggers AMT and you then have a tax credit to use. (See the FAQ about the AMT tax credit on myStockOptions.com.) With NQSOs, the exercise and the sale are separate transactions. You were first taxed on the spread at exercise, and the gain appeared as part of your W-2 and was included in your compensation income on your tax return.
You then owned the stock as you would any other stock you purchased. The decision of when to sell and the treatment of capital gains are like those with any other stock you have bought. Because you held the stock for more than one year, you are taxed at the long-term capital gains rates on your Schedule D. Assuming you sold the stock after May 5, 2003, the gains will be taxed at the maximum rate of 15%.
The only "credit" you get lies in the fact that your basis in the stock to calculate your gains is not just your exercise price. It is your total exercise price plus the amount of compensation income you reported.
Example: You exercised 10,000 NQSOs at $5 each when the current price was $12.80. The total taxable income was $78,000 ($7.80 x 10,000). Your tax basis is $128,000 ($50,000 exercise cost plus $78,000 compensation income). You then sell all the shares for $200,000. Your capital gain is $72,000 ($200,000 - $128,000).
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Here are more selections from myStockOptions.com's newest award-winning educational content. All of these selections are available to our Premium Members and licensees:
What to do when your company does not give you a W-2 reporting your option gains, explained in the FAQs in Tax Center: NQSOs W-2s and Tax Returns.
When you make a timely 83(b) election for your restricted stock within 30 days of grant, you must also file the paper copy of your election form with your tax return. Learn how to do this when you e-file your full tax return: see the FAQs in Tax Center: Restricted Stock & Section 83(b).
Prevent A "Martha Stewart Moment": Insider Trading In Your Company's Stock, by Bruce Brumberg in SEC Law: Insider Trading.
The IRS has redefined "qualified dividends" as dividends on stocks that have been held for at least a 61-day period during the 121-day period (instead of the original law's 120-day period). Read about the details in Tax Center: Tax Cut 2003.
My Company's Being Acquired: What Happens To My Stock Options? (Part 3), by Richard Lintermans in M&A: Tax
Under IRS Revenue Ruling 2004-37, any reduction in the principal amount of recourse notes used to finance your option exercise will be compensation income to you. If your company reduces an outstanding loan to match the decline in the value of stock previously received at exercise, for withholding purposes this is not a basis adjustment but "wages." The IRS indicates that reducing the interest rate or switching the note to non-recourse from recourse would be modifications that generally have the same tax treatment. Look for more IRS rulings and notices this year in response to what the IRS sees as compensation abuses.
In "Weighing Options" (February 2, 2004), BusinessWeek recommends myStockOptions.com for its "slew of educational materials," record-keeper, and calculators. The Wall Street Journal recently mentioned myStockOptions.com's "helpful articles on options strategies" and "calculators to figure after-tax gains from exercising stock options" ("Stock Options Make A Comeback," February 10, 2004).
In an article about Web tax resources, the San Jose Mercury News flattered us by stating that myStockOptions.com is the "first place to turn for news, advice, calculators, and resources to manage just about any kind of compensation your company can throw at you, from stock options and employee stock-purchase plans to pre-IPO stock and restricted stock."
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