Other Income?

[Maria]

Hello:

I am preparing a individual tax return. The client received a 1099-misc. On box 3, other income, shows $550,000, box 7, nonemployee compensation shows $8400. I emailed the broker for the box 3 info and she said it was stock option from serving as board of director of the issuer. I think this $550,000 is self-employment income, but my co-worker disagree with me. The client also has 1099-B showing stock sales of the same company. The client also received a W-2 from the same company, and I think part of ISO stock options were included in Box 1.

Do you think the $550,000 is self-employment income? and it became basis of the stock?

Thank you very much!

[Bees Knees]

Corporate directors are not employees. I suspect the 1099-MISC showing $8,400 as nonemployee compensation is for the corporate director services.

Box 3 of a 1099-MISC is used as a miscellaneous category where the income is probably not subject to SE tax. The instructions for box 3 state: “Generally, report this amount on the “Other income” line of Form 1040 and identify the payment. The amount shown may be payments received as the beneficiary of a deceased employee, prizes, awards, taxable damages, Indian gaming profits, or other taxable income. See Pub. 525, Taxable and Nontaxable Income. If it is trade or business income, report this amount on Schedule C, C-EZ, or F (Form 1040).”

You said the box 3 amount is for stock options from serving as a corporate director. Although corporate directors are defined by law as not employees, corporate officers providing services for his or her corporation in exchange for compensation are employees. Why would a corporation pay incentive stock options to a corporate director? Incentive stock options by their very definition are fringe benefits designed to give an incentive to an employee to do a good job. The very nature of fringe benefits is an employer employee issue. That is why there are special rules for deferring tax on incentive stock options.

I suspect the corporation is in reality trying to provide a fringe benefit to its W-2 employee, not its nonemployee corporate director. They are trying to treat the same person as both an employee and a nonemployee. The nonemployee corporate director status is a very narrow scope of services rendered. I think the amount of services this person provides that would justify such a huge sum of compensation falls under his or her employment status, not his or her corporate director status, and therefore, the ISOs should have been handled through the W-2, not a 1099-MISC.

That being said, if it were put on the W-2 where I think it belongs and not a 1099-MISC, then the proper FICA taxes would have been paid. However, just because an employer tries to evade FICA by putting something on a 1099-MISC does not automatically turn it into self-employment income. You NEVER pay compensation to an employee on a 1099-MISC and say the employee is responsible for his or her own FICA taxes. If it is subject to FICA, it goes on the W-2. So my vote would be to not put it on Schedule C. ISOs are in no way shape or form self-employment earnings from a trade or business, so don’t treat it as such simply because you might think it should have been on a W-2 subject to FICA.

[OldJack]

This could be right. The box 3 amount should probably have been added to the W2 in box 1 and box 12 with the code V and appropriate payroll taxes withheld. If the W2 does not show the benefit of $550,000 then this would be added to other income line on the 1040 and adds to his cost basis for report the sale from the 1099B on 1040 Sch-D. The W2 may have reported the payroll taxes as "uncollected" in box 12 and if so the taxes will be collected by adding the taxes on page 2, line 62, of the 1040. The $8400 is the actual self-employment, for sch-C, paid for services to the board.

[JON]

Board of Directors are given stock options

a lot of the time. United Healthcare, here locally, gave a bunch to directors who were not employees and they even did them retroactively(they are being checked on that). What type of options would be the most interesting. I always get confused with options, but United even gave options to vendors in the old years. As I remember the partnership created income after exercising the options and the partners ended up with the stock and was sold by my client later at another big gain as it just kept going up in price.