Employees who exercised options this year should act soon to avoid a big tax bill later

2008 could be a “perfect storm” for employees who exercised incentive stock options (ISOs) earlier this year, but taking action before the end of the year could avoid a big tax bill next April. With the decline in the stock market, some employees may find they owe more for income taxes than the stock is worth.

“Employees who exercised incentive stock options early in 2008 need to remember that the excess of the fair market value of the stock over the option price on the exercise date is subject to the alternative minimum tax (AMT),” says Michael Gray, CPA, author of Employee Stock Options – Executive Tax Planning and Michael Gray, CPA’s Option Alert newsletter. “But there is an ‘escape hatch’. If the employee sells the stock to an unrelated person before the end of the year of exercise, the AMT adjustment is eliminated and the taxpayer will only pay tax for additional wages on the excess of the selling price over the option price.”

Employees who follow this strategy must avoid violating the “wash sale” rules. “When you use the ‘escape hatch’, you can’t buy stock in the same company back, or even receive or buy an option to purchase the same stock back, during the period thirty days before to thirty days after the date of sale, or you lose the ‘escape hatch’ benefit,” says Mr. Gray.

Congress passed tax relief last October for employees who fell in this tax trap in the “Dot Com Crash” of 2000 – 2001, but did not repeal the AMT for ISO exercises in 2008 and thereafter.

Michael Gray, CPA gives tax planning advice to employees with stock options. You can subscribe to his free newsletter, Michael Gray, CPA’s Option Alert, and find a wealth of information about employee stock options at www.stockoptionadvisors.com. His book, Employee Stock Options – Executive Tax Planning, 2008 Edition is available at Amazon.com.

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Michael Gray

Certified Public Accountant

Michael Gray, CPA

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