Four Tax-Savvy Stock Moves For 2009 and Beyond

Wall Street Journal, 12/23/09, Page C3

http://online.wsj.com/article/SB10001424052748704157304574612532368682034.html?ru=yahoo&mod=yahoo_hs

Summary of the article & comments:

1) Sell Stock Now Before the Law Changes?

A shareholder sold shares in his company and opted to receive CASH instead of taking stock of the same value of the acquiring company (that would have been a tax-free transaction) specifically because he feels tax rates are going up in the U.S. and California. So rather than defer (perhaps for decades) the gain and related tax payments to the IRS and California Franchise Tax Board on the sale of the stock, he decided to pay tax at today’s rates, fearing higher rates in the future.

I comment:
Using the “time-value of money” approach, it almost never, never makes sense to pay tax today that could be deferred into the future (most certainly if the tax-deferral can be decades into the future…even if the tax rates do go up). I’ve seen taxpayers make this mistake before. It is very difficult to predict the outcome of future tax legislation. This taxpayer is very pessimist about future tax rates…but with a $12 trillion federal debt and California another $20 billion out of balance (as of this date), who can blame him?

2) Inventive Stock Options (ISOs)

Consider exercising ISOs before 12/31/09 so that you’ll meet the 12 month holding period to get long-term capital gain treatment by this time in 2010. You have to “exercise” (and pay the “grant price”) to get the 12 month long-term capital gain holding period clock to start ticking in your favor. The article mentions the exercising of ISOs can have horrendous Alternative Minimum Tax consequences, and you should consult a CPA or other tax advisor before exercising ISO shares.

3) Non- Qualified Stock Options (“NQSO”)

Exercise NQSOs with a big gain (current price of the stock in excess of your exercise price) now before tax rates increase.
However, by doing so, be fully aware you are giving up the potential for future appreciation in the stock. So if you save a few percentage points in tax by exercising now, but give up to right to ride the stock to higher prices, the lost investment gain may far, far exceed the potential tax savings. So choose wisely!

4) Restricted Stock

Consider an Internal Revenue Code Sec. 83(b) election. This can also apply to ISOs.

Normally, restricted stock is taxable to the taxpayer as it vests and can be sold.

If you are fearful of higher tax rates, make a Sec. 83(b) election and pay tax on the value of the stock now, even before it vests, at ordinary income tax rates. Further appreciation will be taxed as a capital gain, if you hold the stock for 12 months after the Sec. 83(b) election.
Review all this with a tax advisor BEFORE filing the Sec. 83(b) election. Look at all the requirements. The election must be mailed to the IRS AND be attached to your tax return. Check your current year tax payments (estimated tax payments, withholding, etc.) to make sure you avoid underpayment penalties as a result of the Sec. 83(b) election.

If the employee/taxpayer forfeits the stock (is fired, quits, etc., before the vesting date and never takes ownership rights to the shares), he can’t recover the tax paid at ordinary income tax rates as a result of making the Sec. 83(b) election…although a capital loss should be available.

5) Wash-Sale Traps:

Often, this time of year, taxpayers want to recognize stock losses to offset the taxation of stock gains triggered earlier in the year. As the article mentions, the wash-sale rules can negate the loss sale you intended. The wash-sale rule NEVER negates a gain (people often get confused with this rule).

The “wash sale” rule prohibits taking tax losses while buying the same stock within 30 days before or after the sale of a stock at a loss.
The rationale for the rule is that within the 30 day period, the taxpayer is in the same ownership/economic position in the stock as when they started, so the loss in disallowed.

“A grant of options or restricted stock, or an option exercise ALL COUNT AS BUYING STOCK, so loss sales should be kept far apart from these transactions.”

You can’t assume your stock broker can or will figure this out for you and put you on notice on Form 1099-B. They may not have the information from you stock exercises, etc. The taxpayer is responsible to disallow any losses that are wash-sales when reporting transactions on Form 1040, Schedule D.

Good luck to everyone in 2010.

If you have any questions of comments, please call me or ask for a partner at GROCO at (510) 797 8661.