Tax Planning for Retirees

Receipt of Property or Options from Employer

Using a Nonrecourse Note to Pay for Property Transferred from an Employer. – Unrestricted property (e.g., unrestricted stock) is generally taxable upon its receipt from an employer – unless the property is an option without a readily ascertainable value (or a “qualified” stock option). The tax law will generally treat property as an option if a taxpayer obtains the property by giving his or her employer a nonrecourse note. A note is nonrecourse if it is secured by the property and the taxpayer is not liable for any amount in excess of the property’s value – i.e., the taxpayer has no risk of loss (as in an option).

However, a federal district court has concluded that property received from an employer is not an option merely because the taxpayer pays for the property with funds borrowed from a third party under a nonrecourse note. Miller v. United States, 345 F. Supp. 2d 1046 (N.D. Cal. 2004). See Chapter 10 of the treatise for a discussion of the taxation of property received from an employer.

Exchanges or Amendments of Nonqualified Stock Options. – Generally, stock options granted by an employer are not taxable when received if they do not have a readily ascertainable value (or they are “qualified” stock options). If the options are nonqualified, they are not taxable until exercised or transferred to a third party – even if their value becomes readily ascertainable after receipt.

The IRS has now also ruled that the exchange of a nonqualified stock option without a readily ascertainable value for a new nonqualified stock option (also without a readily ascertainable value) is not taxable at the time of the exchange. Rather, the new option is not taxable until exercised or transferred – even if its value becomes readily ascertainable after receipt. (Ltr. Rul. 200418017.) In fact, such options do not become taxable before their exercise or disposition even if their value becomes readily ascertainable earlier due to a plan amendment allowing
their transfer to a third party. (Ltr. Rul. 200414007.) See Chapter 10 of the treatise for a discussion of the taxation of property (including stock) received from an employer.

Underwriters’ Commissions on IPO of Nonstatutory Stock Not Deductible from Option Exercise Income. –A participant exercising nonstatutory stock options and selling the acquired stock in an initial public offering (IPO) may not treat underwriters’ commissions on the IPO as expenses deductible from compensation income recognized on exercise of the options. Rather, the commissions are capital expenses taken into account in computing gain or loss on sale of the stock, even if the exercise of the options and sale of the stock are virtually simultaneous. (Hann v. United States, 2017-2 U.S.T.C. ¶ 50,308 (Cl. Ct.).) See Chapter 11 of the treatise for a discussion of the taxation of nonstatutory stock options received from an employer.

Qualified Stock or RSUs Derived from Qualified Equity Grants. – For years after 2017, a participant in a qualified equity plan may elect to defer the tax on the bargain element in “qualified stock.” The qualified stock must be issued to a “qualified employee” pursuant to an equity grant awarded by an “eligible corporation.” Such equity grants consist of either stock options or restricted stock units (RSUs), but not both. If an employee receives qualified stock under such a grant, the employee may be able to defer payment of tax on the bargain element for as long five years after the date of vesting. However, the deferral can end earlier upon the occurrence of certain events. (IRC § 83(i); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13603.)

Only an “eligible corporation” may award the qualified equity grants. Among other requirements for eligibility, the corporation must have a written plan that provides grants of stock options or RSUs to at least 80 percent of the corporation’s employees. The IRS has announced that the corporation must grant these options or RSUs during the year of corporate eligibility. That is, the corporation cannot take into account grants in other years for purposes of satisfying the 80 percent rule.

When the deferral period ends, the bargain element becomes subject to income tax withholding at the maximum individual tax rate. The IRS has announced that, to guarantee that the employer can withhold income taxes, the employer must put the deferral stock into an escrow, at least until the bargain element is includable in the employee’s income. The employer may then withdraw from escrow a sufficient number of shares to cover the income tax withholding, to the extent the withholding requirement has not otherwise been satisfied. The employer must then deliver the remaining escrowed shares to the employee. (Notice 2018-97, 2018-52 I.R.B. ___.) See Chapter 11 of the treatise.