Monthly Planning & Business News
Plan carefully when dealing with ISOs
ISOs give employees a "piece of the action" while allowing
employers to attract workers at relatively inexpensive costs.
However, before you accept that job offer, there are some
intricate rules regarding the taxation of ISOs that you
should understand.
How are ISOs taxed?
An incentive stock option is an option granted to you as an
employee which gives you the right to purchase the stock of
your employer without realizing income either when the
option is granted or when it is exercised. You are first taxed
when you sell or otherwise dispose of the option stock. You
then have capital gain equal to the sale proceeds minus the
option price, provided that the holding period requirement
is met.
Note. The IRS has temporarily suspended collection of ISO
alternative minimum tax (AMT) liabilities through
September 30, 2008.
How long do I need to hold ISOs to get capital gain
treatment?
To obtain favorable tax treatment, the stock acquired under
an incentive stock option qualifies for favorable long-term
capital gain tax treatment only if it is not disposed of before
the later of two years from the date of the grant of the
option, or one year from the date of the exercise of the
option. If this holding period is not satisfied, the portion of
the gain equal to the difference between the fair market value
(FMV) of the stock at the time of exercise and the option
price is taxed as compensation income rather than capital
gain. In this case, you may be subject to the higher rate of
income imposed on ordinary income.
For example, your employer granted you an incentive stock
option on April 1, 2006, and you exercised the option on
October 1, 2006, you must not sell the stock until April 1,
2008, to obtain favorable tax treatment (the later of two
years from the date of the grant or one year from the date of
exercise).
What key dates should I remember?
Because of the importance of receiving capital gain
treatment, it is important that you keep in mind key dates
such as the date of grant of the ISO and its date of exercise.
These periods are measured from the date on which all acts
necessary to grant the option or exercise the option have
been completed. Therefore, the date of grant is treated as the
date on which the board of directors or the stock option
committee completes the corporate action which constitutes
an offer of stock, rather than the date on which the option
agreement is prepared. The date of exercise is the date on
which the corporation receives notice of the exercise of the
option and payment for the stock, rather than the date the
shares of stock are actually transferred.
Will I be subject to alternative minimum tax?
The effect of the alternative minimum tax (AMT) on ISOs
can amount to a potential trap for the unwary. This is
because under the regular tax there is no tax until the stock
is sold or otherwise disposed of. Under the AMT, however,
the trap takes place when the ISO is exercised, since
alternative minimum taxable income includes the difference
between the FMV of the stock on the date the ISO is
exercised and the price paid for the stock (the "ISO spread").
If you pay AMT, you are given a credit against regular
income tax for the portion of the AMT attributable to ISOs
and other tax preference items that result in deferral of
income tax. The credit is taken in later years when no AMT
is due, and may be taken to the extent that regular tax
liability exceeds tentative minimum tax liability. The effect of
this is that the AMT is a prepayment of tax, rather than an
additional tax.
Since the AMT only applies if it is higher than your regular
income tax, one strategy is to time the exercise of ISOs each
year to come under the AMT exemption levels. Purely from a
tax standpoint, the ideal situation is to exercise ISOs each
year that would result in AMT equal to your regular tax. Of
course, other factors, such as market conditions, financial
needs, etc. may play a greater role in deciding when to
exercise an option. If you pay high property tax or state
income tax, you may find it more challenging to calculate
the optimum exercise of ISOs in relation to the AMT, since
both of these deductions are counted against their annual
AMT exemption.
ISOs can be a nice additional employee benefit when
considering a job offer. However, because the tax
implications surrounding certain key trigger events related
to ISOs can have a significant impact on your tax liability,
we suggest that you contact the office for additional
guidance.
Leasing property to your own business
Owning property (real or tangible) and leasing it to your
business can give you very favorable tax results, not to
mention good long-term benefits. There are some
drawbacks, however, and you should consider all factors
before structuring such an arrangement.
BENEFITS
Since you own the property personally, it is protected from
the creditors of the Company should it be sued or run into
financial difficulty.
Real estate leasing outside of the corporation will offer better
tax and financial advantages compared to the rental of
personal property such as equipment. These advantages can
include the avoidance of corporate double tax on the
appreciation of the real estate, along with estate planning
advantages from the step up in basis if the property is
owned by the individual or partnership.
Allows the individual taxpayer to remove earnings from the
company without payment of employment taxes or
increasing the possibility of unreasonable compensation
issues.
DRAWBACKS
If you are a non-corporate lessor and leasing personal
property (machinery, equipment, etc.), you will have to
comply with special rules in order to claim the Sec. 179
expense deduction.
You need to charge a fair rental for your real estate or
equipment. Inflated rental rates may be recharacterized as
dividends if coming from a corporation.
Leasing property to your own C Corporation cannot
generate passive income. Income will be reclassified as
"active" while losses will remain "passive", removing the
ability to use this transaction to offset other "passive" losses.
Proper planning and knowledge of the various tax issues is
important when considering this type of arrangement. Feel
free to contact us for a better understanding of how these
situations would effect you before you proceed.
Back
------------------------------------------------------------------------------
If and only to the extent that this publication contains
contributions from tax professionals who are subject to the
rules of professional conduct set forth in Circular 230, as
promulgated by the United States Department of the
Treasury, the publisher, on behalf of those contributors,
hereby states that any U.S. federal tax advice that is
contained in such contributions was not intended or
written to be used by any taxpayer for the purpose of
avoiding penalties that may be imposed on the taxpayer by
the Internal Revenue Service, and it cannot be used by any
taxpayer for such purpose.
Plan carefully when dealing with ISOs
ISOs give employees a "piece of the action" while allowing
employers to attract workers at relatively inexpensive costs.
However, before you accept that job offer, there are some
intricate rules regarding the taxation of ISOs that you
should understand.
How are ISOs taxed?
An incentive stock option is an option granted to you as an
employee which gives you the right to purchase the stock of
your employer without realizing income either when the
option is granted or when it is exercised. You are first taxed
when you sell or otherwise dispose of the option stock. You
then have capital gain equal to the sale proceeds minus the
option price, provided that the holding period requirement
is met.
Note. The IRS has temporarily suspended collection of ISO
alternative minimum tax (AMT) liabilities through
September 30, 2008.
How long do I need to hold ISOs to get capital gain
treatment?
To obtain favorable tax treatment, the stock acquired under
an incentive stock option qualifies for favorable long-term
capital gain tax treatment only if it is not disposed of before
the later of two years from the date of the grant of the
option, or one year from the date of the exercise of the
option. If this holding period is not satisfied, the portion of
the gain equal to the difference between the fair market value
(FMV) of the stock at the time of exercise and the option
price is taxed as compensation income rather than capital
gain. In this case, you may be subject to the higher rate of
income imposed on ordinary income.
For example, your employer granted you an incentive stock
option on April 1, 2006, and you exercised the option on
October 1, 2006, you must not sell the stock until April 1,
2008, to obtain favorable tax treatment (the later of two
years from the date of the grant or one year from the date of
exercise).
What key dates should I remember?
Because of the importance of receiving capital gain
treatment, it is important that you keep in mind key dates
such as the date of grant of the ISO and its date of exercise.
These periods are measured from the date on which all acts
necessary to grant the option or exercise the option have
been completed. Therefore, the date of grant is treated as the
date on which the board of directors or the stock option
committee completes the corporate action which constitutes
an offer of stock, rather than the date on which the option
agreement is prepared. The date of exercise is the date on
which the corporation receives notice of the exercise of the
option and payment for the stock, rather than the date the
shares of stock are actually transferred.
Will I be subject to alternative minimum tax?
The effect of the alternative minimum tax (AMT) on ISOs
can amount to a potential trap for the unwary. This is
because under the regular tax there is no tax until the stock
is sold or otherwise disposed of. Under the AMT, however,
the trap takes place when the ISO is exercised, since
alternative minimum taxable income includes the difference
between the FMV of the stock on the date the ISO is
exercised and the price paid for the stock (the "ISO spread").
If you pay AMT, you are given a credit against regular
income tax for the portion of the AMT attributable to ISOs
and other tax preference items that result in deferral of
income tax. The credit is taken in later years when no AMT
is due, and may be taken to the extent that regular tax
liability exceeds tentative minimum tax liability. The effect of
this is that the AMT is a prepayment of tax, rather than an
additional tax.
Since the AMT only applies if it is higher than your regular
income tax, one strategy is to time the exercise of ISOs each
year to come under the AMT exemption levels. Purely from a
tax standpoint, the ideal situation is to exercise ISOs each
year that would result in AMT equal to your regular tax. Of
course, other factors, such as market conditions, financial
needs, etc. may play a greater role in deciding when to
exercise an option. If you pay high property tax or state
income tax, you may find it more challenging to calculate
the optimum exercise of ISOs in relation to the AMT, since
both of these deductions are counted against their annual
AMT exemption.
ISOs can be a nice additional employee benefit when
considering a job offer. However, because the tax
implications surrounding certain key trigger events related
to ISOs can have a significant impact on your tax liability,
we suggest that you contact the office for additional
guidance.
Leasing property to your own business
Owning property (real or tangible) and leasing it to your
business can give you very favorable tax results, not to
mention good long-term benefits. There are some
drawbacks, however, and you should consider all factors
before structuring such an arrangement.
BENEFITS
Since you own the property personally, it is protected from
the creditors of the Company should it be sued or run into
financial difficulty.
Real estate leasing outside of the corporation will offer better
tax and financial advantages compared to the rental of
personal property such as equipment. These advantages can
include the avoidance of corporate double tax on the
appreciation of the real estate, along with estate planning
advantages from the step up in basis if the property is
owned by the individual or partnership.
Allows the individual taxpayer to remove earnings from the
company without payment of employment taxes or
increasing the possibility of unreasonable compensation
issues.
DRAWBACKS
If you are a non-corporate lessor and leasing personal
property (machinery, equipment, etc.), you will have to
comply with special rules in order to claim the Sec. 179
expense deduction.
You need to charge a fair rental for your real estate or
equipment. Inflated rental rates may be recharacterized as
dividends if coming from a corporation.
Leasing property to your own C Corporation cannot
generate passive income. Income will be reclassified as
"active" while losses will remain "passive", removing the
ability to use this transaction to offset other "passive" losses.
Proper planning and knowledge of the various tax issues is
important when considering this type of arrangement. Feel
free to contact us for a better understanding of how these
situations would effect you before you proceed.
Back
------------------------------------------------------------------------------
If and only to the extent that this publication contains
contributions from tax professionals who are subject to the
rules of professional conduct set forth in Circular 230, as
promulgated by the United States Department of the
Treasury, the publisher, on behalf of those contributors,
hereby states that any U.S. federal tax advice that is
contained in such contributions was not intended or
written to be used by any taxpayer for the purpose of
avoiding penalties that may be imposed on the taxpayer by
the Internal Revenue Service, and it cannot be used by any
taxpayer for such purpose.
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