ISO - Disqualifying disposition

[drc34718]

I previously asked a question regarding restricted stock reproting..It turns out that the "restricted stock" is actually an ISO offering, now verified through the company form my client signed as opposed to what the broker told her. BeesKnees had answered and I appreciate the response

Anyway, I know have a question to a situation that I can't quite seem to get a definitive answer to and hope someone may have dealt with this previously.

My client has a large AMT impact in 2005 from the exercise of the options - option price $8.28 and exercise price $18..AMT impact approx. $60K. Broker advised her to sell these options to cover the AMT tax due on these and some other ISO's she has received. The sale of this stock is a disqualifying disposition due to the exercise date of 8/05 and sale date of 6/06 (less than one year and only a few have a life more than 2 years after grant date). Rules stipulate that ordinary income to the extent of $9.72 ($18 - 8.28 per share) and capital gain income on $10 per share (as sell price was $28 per share)..Problem with this is that sale occurred before cap gain time frame so additional ordinary income on the sale to the extent of $10 per share.

My comment is to the $9.72 per share. From what I can discern, this is compensation income but it also appears that the employer has no obligation to withhold on the disqualifying disposition.

Does anyone have experience with this and how is this additional "compensation income" reported? Can an estimated paymente be made otherwise?

Thanks in advance,

Dale Cooper

[Bees Knees]

IRS Pub 15-B says the following:

EMPLOYEE STOCK OPTIONS

There are three kinds of stock options-incentive stock options, employee
stock purchase plan options, and non-statutory (nonqualified) stock
options.

Wages for social security, Medicare, and federal unemployment taxes
(FUTA) do not include remuneration resulting from the exercise after
October 22, 2004, of an incentive stock option or an employee stock
purchase plan option, or from any disposition of stock acquired by
exercising such an option. The IRS will not apply these taxes to an
exercise before October 23, 2004, of an incentive stock option or an
employee stock purchase plan option, or to a disposition of stock acquired
by such exercise.

Additionally, federal income tax withholding is not required on the
income resulting from a disqualifying disposition of stock acquired by the
exercise after October 22, 2004, of an incentive stock option or an
employee stock purchase plan option, or on income equal to the discount
portion of stock acquired by the exercise after October 22, 2004, of an
employee stock purchase plan option resulting from any disposition of the
stock. The IRS will not apply federal income tax withholding upon the
disposition of stock acquired by the exercise before October 23, 2004, of
an incentive stock option or an employee stock purchase plan option.
However, the employer must report as income in box 1 of Form W-2, 1) the
discount portion of stock acquired by the exercise of an employee stock
purchase plan option upon disposition of the stock, and 2) the spread
(between the exercise price and the fair market value of the stock at the
time of exercise) upon a disqualifying disposition of stock acquired by
the exercise of an incentive stock option or an employee stock purchase
plan option.

The spread on nonstatutory options normally is included in wages for
income tax purposes when the options are exercised. (See Regulations
section 1.83-7.) The spread on nonstatutory options is subject to social
security, Medicare, FUTA, and federal income tax withholding at the time
of exercise.

An employee who transfers his or her interest in non-statutory stock
options to the employee's former spouse incident to a divorce is not
required to include an amount in gross income upon the transfer. The
former spouse, rather than the employee, is required to include an amount
in gross income when the former spouse exercises the stock options. See
Revenue Ruling 2002-22 and Revenue Ruling 2004-60 for details. You can
find Rev. Rul. 2002-22 on page 849 of Internal Revenue Bulletin 2002-19 at
www.irs.gov/pub/irs-irbs/irb02-19.pdf. You can find Rev. Rul. 2004-60 on
page 1051 of Internal Revenue Bulletin 2004-24 at www.irs.gov/pub/irs-
irbs/irb04-24.pdf.

For more information about employee stock options, see sections 421,
422, and 423 of the Internal Revenue Code and the related regulations.

[Bees Knees]

As you said, it appears that income tax withholding is not required for a disqualifying disposition, even though it is basically treated as compensation income (ordinary income). Even so, I believe it would still be added to box 1 of the W-2 as wages.

[drc34718]

thanks

Appreciate the reference. appears that basically the ISO's become treated like NSO's but without the requisite withholding.. I think since the W-2 needs to be modified, and since my client has never made ES payments, will see if employer will remit the taxes on her behalf. Might sve a few dollars of possible ES underpayments..

Thanks again for the response..very helpful forum..