Double Taxation

The liquidity condition is satisfied upon the occurrence of a qualifying event, defined as a change of control transaction or six months following the completion of our initial public offering. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. But this calculation failed to take into account the fact that the director should have been entitled to deduct the "cost" of the warrants Welfare loss of taxation refers to the decreased economic well-being Yes, I am happy to received promotional communications from Mondaq. In theory, the payment of AMT in the year of exercise creates a credit which then reduces the regular tax in the year the stock is actually sold, since in that year, disregarding all other factors, the regular taxable income would be larger than the AMT taxable income, owing to the differences in the stock basis.

Anyone who participates in an employee stock option or stock purchase plan at work could overpay their taxes — perhaps by a lot — if they don’t understand a reporting requirement that took.

What is 'Double Taxation'

One of the directors was offered 2. For withholding tax purposes, the company calculated taxable income based on the average price of the shares traded on the SET in April The company collected the withholding tax from the director and paid it to the Revenue Department.

The chart illustrates the flow of events. The director then applied for a withholding tax refund from the Revenue Department, claiming he had not derived taxable income upon receipt of the warrants since there was no trading price on the issue date. He acknowledged tax liability only for capital gains derived from the subsequent sale of the remaining warrants outside the SET. But the court said since the warrants were embedded with the rights to purchase shares at 4.

The next issue involved determining the taxable value of the warrants received on April 1, , as they were issued for free and there was no trading price until they were listed on April 21 of that year. The Central Taxation Court applied the opening price of The Supreme Court disagreed. It said the company had analysed the potential dilution effect and concluded the issue of warrants would reduce its share value by 4.

The Supreme Court accepted as correct the value prepared by the company in computing withholding tax But since the Revenue Department failed to appeal on this issue, the Supreme Court had to accept the price of While the taxable income, determined at the time of exercise, will be treated as ordinary income subject to withholding, any additional appreciation in the value of the stock after a taxable exercise of the option may qualify for capital gain treatment, if the capital gain holding requirements are met.

For example, in this situation, suppose that options to purchase BigDeal. If, at the time of exercise, the fair market value of BigDeal. The foregoing analysis has assumed that the stock acquired through the exercise of the option is otherwise unrestricted property -- i.

Here, in the case of BigDeal, there are restrictions on the transferability of the stock, and BigDeal. In this instance, the repurchase right effectively requires the employee to resell to BigDeal.

In other words, because of the limitations on transfer and the presence of a substantial risk of forfeiture, the exercise of the BigDeal. It is also important to remember that under some circumstances, restrictions on stock transfer and vesting requirements may be waived by a company. At the same time, however, other, non-contractual restrictions, such as securities law provisions, may effectively preclude the shareholder from selling the stock.

One potential advantage of making such an election is to cause all appreciation after that point to qualify for capital gain treatment and to start the running of the capital gains holding period, which would otherwise be delayed until the restrictions lapse and the stock becomes fully vested.

Further suppose that because of the restrictions on the stock, all "unvested" shares are treated as subject to limits on transferability and a substantial risk of forfeiture i. Additional appreciation after that point could qualify for capital gain treatment if the stock were retained for the requisite holding period, measured from that point onward. ISO plans have two potentially important advantages to employees, in comparison to non-statutory stock options.

Second, if the stock is held until at least one year after the date of exercise or two years from the date the option is granted, whichever is later , all of the gain on the sale of the stock, when recognized for income tax purposes, will be capital gain, rather than ordinary income. If the ISO stock is disposed of prior to the expiration of that holding period, then the income is ordinary income.

The basic requirements for an ISO plan are set out in I. Thus, there are two significant differences between ISO's and non-statutory options. Second, if the ISO holding period requirements are met, all gain will qualify for capital gain treatment. This "spread" is treated as an AMT adjustment. The effect of this AMT adjustment is to cause the taxpayer to recognize AMT taxable income on the exercise of the option, when the stock acquired is substantially unrestricted or not subject to a substantial risk of forfeiture.

Regardless of when the AMT adjustment arises, it has several effects. First, the AMT adjustment -- the spread between the fair market value and the option price -- can become subject to AMT, and AMT tax may have to be paid on that amount, even though the stock might be held for many years or ultimately sold at a loss.

In addition, the basis in the stock, for AMT purposes only, becomes in effect the fair market value as of the date that the AMT adjustment arises. Because of this basis adjustment, when the stock is actually sold, there will be no AMT gain to the extent of the "spread" that was previously subject to AMT tax.

Because the basis in the stock will be different for AMT and for regular tax purposes, the subsequent sale of the stock will generate gain or loss for regular tax purposes, even if it generates no gain for AMT purposes. Since the gain on the sale, determined for purposes of the regular tax, would also include the "spread" that was previously included in the AMT taxable income, there is a risk of double taxation, except for the AMT credit, as determined under I.

In theory, the payment of AMT in the year of exercise creates a credit which then reduces the regular tax in the year the stock is actually sold, since in that year, disregarding all other factors, the regular taxable income would be larger than the AMT taxable income, owing to the differences in the stock basis.

This is, at least, the theory, in greatly simplified form. The Facebook S-1 further provides:. Putting this all together, does this mean that the RSUs issued to employees upon vesting six months after the IPO date cannot be sold for another six months? This is an important question, because based on my understanding of the relevant case law and underlying congressional reports, the Rule restriction is not considered a restriction on transferability worthy of postponing the recognition of income under Section As a result, the employees would be required to recognize compensation income upon receipt of the stock on November 18, , even though they cannot sell it pursuant to Rule for an additional six months.

This would lead to two problems:. The employees would not be able to sell the stock in order to pay the tax on the compensation income recognized upon vesting.

There is a risk that the value of the stock on the vesting date will exceed the value six months later, when the shares can be freely traded.

It appears based on discussions on the Internet — and when have anonymous web comments ever led us astray?

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Posts about stock options written by WithumSmith+Brown, PC. 1 The State and Local Tax Lawyer September 15, Stock Option Income – Double Taxed Income By: Debra L. Silverman I. INTRODUCTION. Capable and loyal employees are prized by all businesses, and large companies often seek to keep their top talent by rewarding qualified personnel through an employee stock option plan (Esop).