Capital Gain or Self-Employment Income

[Maria]

Hello,

One of my clients is an US citizen works in overseas currently. During 2001 he worked as an consultant for an bio-tech company in the US, he received some stock options as compensation in 2001. In 2006, the bio-tech company was acquired by Merck, and he received $500,000. Merck issued him 1099-misc. showing $500,000 in box 7, non-employee compensation. I believe only the Fair Market Value of the stock option in 2001 was self-employment income, the increase in value from 2001 to 2006 is long-term capital gain. However, Merck's tax department refused to reissue him another 1099. If I help my client to file his return showing a small SE income and large L-T capital gain, is IRS going to accept?

Thanks very much for your help.

[ED SMITH]

First of all, you will have to estabish a basis for the stock. He may already have been taxed on the options when they were exercised in 2001. This would establish the basis. Hopefully the client still has records from that year, because they would be needed in the event of an audit.

Then you can offset the $500K on Sch C, and enter the correct amounts on Sch D.

The $500K should be entered on Sch C as income. Then, it should be entered on page 2 as "Capital Gain Offset - see Sch D"

This way the $500K will match the IRS records.

Good Luck!

[Snaggletooth]

Accountability

Assuming this guy already took income from the predecessor company, the difference between that basis and the $500,000 should be capital gains.

This should be a 1099-B situation. Not necessarily from Merck, but possibly from the registered agent.

Instead of ganging up on the taxpayer, why shouldn't Merck be accountable for what they are screwing up? Ed Smith has presented a good reporting mechanism to bail out the taxpayer, but why shouldn't IRS go after Merck with the same fervor they will go after the shareholder?? Especially when it has been brought to their attention and they refuse to do anything about it.

[DonPriebe]

Just the facts maam

One of my clients is an US citizen works in overseas currently. During 2001 he worked as an consultant for an bio-tech company in the US, he received some stock options as compensation in 2001.

OK.

First of all, you will have to establish a basis for the stock. He may already have been taxed on the options when they were exercised in 2001.

Why do we think the options were exercised in 2001?

If he were an employee of the company and was issued stock options in 2001, and did not exercise them that year, it would not be a taxable event for regular tax purposes. [Note - yes, it would be for AMT, but that's another story.] If he then did a cashless exercise in a later year, his gain would be ordinary income and show up in box 1 of his W2. [Also in box 14 code V].

Why are we so sure that the 1099-MISC treatment is wrong for a non-employee?

[OtisMozzetti]

I agree with the vast majority of what Don Priebe said, although...

OK.
If he were an employee of the company and was issued stock options in 2001, and did not exercise them that year, it would not be a taxable event for regular tax purposes. [Note - yes, it would be for AMT, but that's another story.] If he then did a cashless exercise in a later year, his gain would be ordinary income and show up in box 1 of his W2. [Also in box 14 code V].

Being GRANTED (issued) options, be they nonqualified or be they ISOs (incentive stock options, statutory options), is not a taxable event for regular tax purposes nor for AMT purposes. For that matter, the stock price might never increase beyond the grant price.

On the other hand, when statutory stock options, or ISOs, get EXERCISED and the stock is held beyond the end of the tax year, then there is AMT income, but not regular tax income, to the extent of the bargain element at the time of exercise. That income is reflected in a higher basis in the stock for AMT purposes than for regular tax purposes. When nonqualified options get exercised, the bargain element results in ordinary income at the time of exercise.

[Maria]

Thanks

Thanks everybody. Your advice not only give me thoughts and knowledge but also courage.