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Optical/IP

Option Tax Nightmares Teach Lessons

April 15 has come and gone, and many optical networking professionals are still feeling the sting in their wallets.

The problem is most acute for those saddled with the so-called alternative minimum tax (AMT), a separate tax system that often applies to employees granted stock options. The AMT, coupled with a plummet in the Nasdaq, has created a situation in which many employees can’t sell enough stock to cover their huge tax bills.

Some employees who exercised their incentive options when the market was at its height now find themselves with six-digit tax bills. Some companies are reportedly helping certain employees with loans and cash to help pay off the debt, but for the most part have been left on their own to muddle through.

“We don’t provide financial assistance,” says Steve Langdon, a Cisco Systems Inc. (Nasdaq: CSCO) spokesperson. “What we do is explain the issues to people when we allocate the options, and we refer people to professionals to help them plan.”

Employers can offer two kinds of stock options: nonqualified (NQSOs) and incentive (ISOs). Both kinds of options are taxed on the spread between the exercise price and the market price at exercise. But with nonqualified options, the company either withholds taxes from the proceeds of the sale of the stock or requires the employee to come up with the taxes it needs to withhold.

On the other hand, incentive options are not subject to income tax withholding when they are exercised. If an employee immediately sells the stock, the tax on the spread is paid in April with the annual tax return.

If he or she holds the shares and doesn’t sell them in the same calendar year they were exercised, at the end of the year two tax rates will be calculated: A tax on the regular income and the potential tax on the employee's options -- the AMT. That's when an employee can get socked with a huge tax bill, which, because of the lowered share price, can't be covered by selling stock.

“What happened this year is that the stock has dropped so low they can’t pay off the taxes,” says Bruce Brumberg, editor and chief of MyStockOptions.com, a site dedicated to providing information on options. “But they will get it all back eventually in the form of tax credits. The problem is that it takes a really long time for them to recoup the losses through the credits.”

While the AMT has been criticized this year, the truth is that people can benefit from it when the stock price is on the rise. For example, if a share price has risen only nominally after the stock options are exercised, the employee will pay a modest AMT, but could hold the shares long enough to sell them at long-term capital gains rate, ending up paying a much more favorable tax rate than if they had been taxed as ordinary income.

The problem that occurred this year has been well publicized and has even penetrated the awareness of our elected representatives. House Democrat Zoe Lofgren, who represents part of the Silicon Valley, introduced a bill, along with 13 other Democrats, to exclude incentive stock-option plans from the AMT. The bill would be retroactive to Jan. 1, 2000, and is now awaiting action in committee. A group of high-tech professionals, including some from Cisco, have organized to help lobby for the passage of this bill.

While Congressional relief could help some people, the crux of the problem has more to do with awareness than with the tax code, according to Brumberg.

“A lot of people out there, aren’t very savvy about their options and how to handle them,” he says. “Sometimes the AMT can be very beneficial to people.”

While it’s too late to make changes on this year’s return, Brumberg offers these hints to help prevent problems in the future.

Know which kind of options you have: Independent contractors or outside directors can only be given nonqualified options by law. But employees of the company are often given a mix of incentive and nonqualified options. To figure out which ones you have, look at your grant document.

Exercise options early in the year: People who plan to hold onto options instead of selling them right away, should exercise those options earlier in the year rather than later. This gives them more flexibilty to plan for the future.

Develop a financial plan: Options should be viewed as an integral part of your compensation, says Brumberg. This means that people should plan what they want to do with the money and work towards optimizing their gains. This is money that could be used to, say, buy a house or finance an education. “You shouldn’t think of this as found money,” he says. “That can be an expensive use of the options.”

Be aware of key dates: Key dates like the end of a vesting period or the end of the options period are important to note. For example, people who often change companies have a shortened exercise period. Usually they must exercise their options when they leave or 90 days after they are gone.

For more information on options, check out Brumberg’s site, www.MyStockOptions.com.

-- Marguerite Reardon, senior editor, Light Reading http://www.lightreading.com

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Rugger 12/4/2012 | 8:33:40 PM
re: Option Tax Nightmares Teach Lessons More power to you, Zoe! I could use some relief for my year 2000 tax bill. AMT sucks!
OpticalValueLine 12/4/2012 | 8:33:37 PM
re: Option Tax Nightmares Teach Lessons We support you!
netskeptic 12/4/2012 | 8:33:37 PM
re: Option Tax Nightmares Teach Lessons 13 Democrats proposing a retroactive tax cut for for the rich, unbeleivable.

Thanks,

Netskeptic
netskeptic 12/4/2012 | 8:33:31 PM
re: Option Tax Nightmares Teach Lessons To fk and csco.

Do not get me wrong, I feel your pain.

However, considering the level of technical discussion we are having here sometimes I would suppose that almost everybody on this list makes 100K+, which qualifies every ------- single one of us to be filthy rich.

And I still find it amazingly hypocritical to see some pinko like Zoe trying to make political capital here.


Thanks,

Netskeptic

Dawg 12/4/2012 | 8:33:31 PM
re: Option Tax Nightmares Teach Lessons Why does this amaze anyone? The Feds have always looked for more and better ways to take your money, so why is this any different?

Bottom line is that folks in the telecom industry are driving the future worth of this country by working hard and long hours. They should be rewarded, not penalized. But as long as our gargantuan government exists the way it does, that will never happen. Remember, to them RICH = EVIL!
csco 12/4/2012 | 8:33:31 PM
re: Option Tax Nightmares Teach Lessons netskeptic

This is a very real problem; please talk at
length with someone affected to realize how
bad it can be and how easily someone can get
trapped.

It has not affected just the "paper rich"
some of whom have, by the way, been bankrupted by
this but even people with moderate paper wealth
which has now turned into a painful debt
to the IRS. People are resorting to selling their
assets, homes etc to pay these tax bills. I know
people who did exactly as their tax/financial
advisors recommended and are now facing large tax
debts.

Any law which can cause tax payers to go
from paper assets to severe actual (not paper)
debts and that to the US government
without ever realizing actual gains
has a serious problem with it and should
absolutely be repealed asap.

Please be supportive or at least do not
make light of the situation. It is very serious
and Congresswoman Lofgren should be commended
highly for having the vision to propose
this legislation.
fk 12/4/2012 | 8:33:31 PM
re: Option Tax Nightmares Teach Lessons >13 Democrats proposing a retroactive tax cut for for the rich, unbeleivable.

Well, it's ok for democrats to pass a targeted tax cut for the rich if it will help keep them in office...

Anyway, the AMT needs a major revamping, as do the tax rules on all options. I didn't get an AMT bill this year because I got so hosed on the NQ options exercise mandated by my leaving my last job. Taxed on the entire spread at "regular income" rates was a real ream job. And of course they are worth less than my new basis. I just find it unfortunate that we are forced to sell stock we'd otherwise prefer to hold simply to pay the taxes on this imputed income. Taxes should be imposed only on actual income, not paper gains, unless congress is willing to let us also deduct paper losses. Grrr. My tax bill this year was more than I made two years ago, yet my standard of living hardly changed at all. Something seems not right about this...
Dawg 12/4/2012 | 8:33:30 PM
re: Option Tax Nightmares Teach Lessons Personally, I fell short of $100k last year, and still have hefty student loans to pay off. I am not rich but I was taxed like it last year.

I am all for whiny, shifty pinko-libs gaining all the political capital they want as long as they are reducing taxes to get it. Not like we'll really get all that much, but something is better than nothing. Heck, if Carter were still president, we'd still be paying 70% income tax.
Raymand 12/4/2012 | 8:33:29 PM
re: Option Tax Nightmares Teach Lessons The real danger of options is that any resulting tax survives bankruptcy. If you end up with say $400K tax on $1M of just excercised options that subsequently collapse to $40K, you'll never escape the $360K difference.

Since to most of us this is real money, the only wise thing to do is sell enough stocks to pay the taxes on the day you excercise, and pay the tax on that day! To do otherwise is like not carrying insurance.
sonet49er 12/4/2012 | 8:33:29 PM
re: Option Tax Nightmares Teach Lessons Everyone who is getting nailed for the AMT for exercising options made the decision to hold onto their stock for a year for long term capital gains rather than cashing out immediately and paying regular income tax.

Greed got the victims into this circumstance. I believe currently under these extreme hardship situations the IRS will settle for a lesser amount of money already. See a good tax lawyer if you are suffering AMT burns.

Having the goverment unilaterally and retroactively bail out everyone will undoubtably have unenvisioned consequences.
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