The myStockOptions.com Blog

Employee Stock Purchase Plans: Recent Survey And New Research Show The Persistence And Importance Of ESPPs

We have always been a big fan of employee stock purchase plans and have an extensive section about ESPPs on myStockOptions.com. A new survey by Fidelity, summarized in a press release, reveals that over half of the surveyed companies (51%) plan to modify their ESPPs in the next few years, and that 31% will make their plans more attractive for participants by, for example, increasing the purchase-price discount or adding a lookback provision.

This is a cheering development after some of the trends the NASPP observed in its 2011 stock plan survey. The results showed that, among the surveyed ESPP companies, the percentage with a 15% discount on the purchase price fell from 87%  in 2004 to 71% in 2011, while the percentage with lookbacks dropped from 82% in 2004 to 62% in 2011. (For more survey data on recent ESPP trends, see an FAQ on myStockOptions.com.)

A company's ESPP is available to all of its employees, a refreshing contrast with the recent corporate trend of narrowing the population that receives stock options and restricted stock. It is good to see how companies view their ESPPs, as reflected in Fidelity's survey:

• 50% of the surveyed companies consider an ESPP to be part of the company's benefits package, as opposed to a form of compensation.
• 72% consider ESPPs to be as valuable as pensions and dental benefits, and more valuable than company-provided life insurance.
• 28% believe their employees value their ESPP more than other company benefits.

It is also good to see that this survey generated news-media interest in the benefits of ESPPs. See, for example, articles in the San Francisco Chronicle and in Forbes.

While it is understandable that many employees find ESPPs an alluring way to immediately sell stock for a quick profit (i.e. flipping), an advisor quoted by The Wall Street Journal in an article discussing the Fidelity survey recommends that employees contribute enough to their 401(k) plans to receive any available company match before they consider participating in an ESPP. Other advisors caution ESPP participants to remember the need to diversify investments beyond their own company's stock, and they also encourage employees to fully understand the tax treatment of ESPP participation.

Can ESPP Participation Predict Stock-Price Trends?

In a research paper published on Social Science Research Network (Do Non-Executive Employees Have Information? Evidence From Employee Stock Purchase Plans), professors Ilona Babenko of Arizona State University and Rik Sen of Hong Kong University of Science and Technology examine whether ESPP participation can predict the future direction of a company's stock price. While most academic research on stock trades focuses on what senior executives are doing, this may be one of the first papers that analyzes stock-trading by rank-and-file employees. The researchers found that stock prices of companies in the top half of aggregate ESPP purchases outperform those in the bottom half by up to 8% during  the year after purchases. "Since ESPP purchases reflect the decisions of thousands of employees...they can provide a reliable signal of future performance," the authors claim. They also found that an increase in participation by lower-level employees can be associated with a higher probability of good news ahead for the company, such as a takeover, while a decrease in participation may signal hard times ahead, such as an earnings restatement.

The Dreaded AMT: How To Find Out Whether Your ISO Exercise Will Trigger The Alternative Minimum Tax

Generally, for each tax year you pay either your regular-tax liability or your alternative minimum tax (AMT) liability, whichever is higher. For most people, the regular-tax liability always turns out to be greater, so the AMT never comes into play. Unfortunately, however, the AMT is hitting a growing number of mere middle-income taxpayers, including people who exercise incentive stock options (ISOs) and hold the shares. This risk is especially pertinent for those who live in high-tax states, itemize tax deductions, and/or have significant personal exemptions, particularly if they exercise and hold ISOs with a big spread. To help your AMT planning, a recently updated FAQ at myStockOptions.com presents a table showing AMT trigger points across a wide range of yearly incomes. For example, if in 2013 you have regular taxable income of $200,000, all it takes to trigger the AMT is a positive adjustment (e.g. ISO spread at exercise) of only $9,163 for joint filers or $8,090 for a single filer.

Over the past several years, Congress has had to take special measures to restrain the spread of the AMT and thus keep it from unfairly taxing millions of people (see the related FAQ on recent developments). In the American Taxpayer Relief Act of 2012, Congress made three major changes in the AMT calculation but did not eliminate the AMT (see the FAQ with details of the changes).

If you are in danger of triggering the AMT, you may be interested in our FAQ that explains various ways to minimize AMT exposure. One strategy involves year-end or year-beginning exercise. Some advisors suggest exercising ISOs at the end of each year, when you can safely estimate whether you will owe AMT for that year. The idea here is to exercise ISOs up to a point at which the aggregate ISO spread will not trigger the application of AMT (i.e. to equalize your AMT and regular-tax liability). For more on this strategy, see a related FAQ on myStockOptions.com. Others advise employees to exercise ISOs in the first quarter of a year: if the stock price drops you can sell the ISO shares later during the same calendar year and avoid paying AMT on paper profits. (See a related FAQ with examples of tax treatments that may apply after a disqualifying disposition in the same year as exercise.) Alternatively, if the stock price rises, you hold the shares. By tax-return time the following year, you will have satisfied the ISO holding periods, so all your gain over the exercise price will be long-term capital gain. When you file your tax return before April of the next year, should you then sell some of the ISO stock to pay AMT, you will at least receive long-term capital gains tax treatment on the appreciation of the sold shares.

Stock Comp Taxation: Tax Return Deadline, How To Get An Extension, And What To Consider For Your Estimated Taxes In The Year Ahead

For those who haven't yet filed, the clock is ticking down for federal tax returns. For taxpayers in the US, the deadline for filing tax returns with the IRS for the tax year 2012 is April 15 (Monday).

In any tax season, the recognition of income from stock compensation or an employee stock purchase plan can complicate your return. Examples include income from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock. However, as regular readers of this blog will know, this tax season has the potential to be more confusing than most if you sold any stock last year. For stock sold during 2012, you must file with your tax return the new IRS Form 8949 along with Schedule D. Both forms were revised for this tax season. (Form 8949 was introduced just last year, prompting significant changes in Schedule D.) These revisions stem from the expansion of the information that brokers must report to you on IRS Form 1099-B. For help, including annotated diagrams of Form 8949 and Schedule D, see the special section of myStockOptions.com called Reporting Company Stock Sales.

IRS Deadline Extensions For Tax Returns

The new IRS forms may cause more late filing than usual this year. If you can't beat the buzzer, you can get an extension of the federal filing deadline by up to six months. No explanation or signature is needed. You can request an extension in any of three traditional ways: on IRS Form 4868, through a paid tax preparer, or via tax-return software.

Note that an extension for your federal tax return applies only to the filing of your return, not to the tax itself, which you must pay by the original IRS filing deadline. Therefore, if you get an extension you must accurately estimate how much tax you must pay by the 15th. By paying 100%, you avoid interest and penalties; if you can't manage that, you can still avoid the penalty by paying 90%. If you owe additional taxes when you eventually file, you will have to pay interest on the unpaid amount going back to the original April due date.

For more details on extensions to file and the penalties for the late payment of taxes, see the related FAQ at myStockOptions.com.

Looking Ahead: 2013 Income

When your tax returns are finally done and you're ready to move on with your life, you may want to make projections of your income in 2013. First, individuals who expect income of more than $200,000 this year ($250,000 for married joint filers) should consider the additional Medicare taxes on ordinary income and investment income that became effective at the start of 2013.

Next, if you expect additional income from stock comp in 2013, and if your salary withholding and the withholding at the statutory rate for supplemental income (25%, or 39.6% for amounts over $1 million) will be inadequate to cover the taxes you will owe for the full year, you may want to make estimated tax payments, or at least see whether you can adjust your salary withholding. To avoid penalties, be sure that you pay the IRS either 90% of your expected tax bill or 100% of this year's taxes (for adjusted gross incomes over $150,000, it is 110%). Penalties are calculated quarterly, so you must make estimated tax payments in the quarter when you earned the income.

Note: Details of estimated taxes, including the due dates, are discussed in IRS Form 1040-ES, and on myStockOptions.com in the sections NQSOs, ISOs, Restricted Stock, and SARs.

Got Eight Minutes? Watch Our Video About Mistakes To Avoid When Reporting Stock Sales On Tax Returns

If there's a way to make learning about tax forms fun, we'll try it. In the Tax Center at myStockOptions.com, our animated presentation about reporting company stock sales on tax returns covers the expanded IRS Form 1099-B and cost basis reporting, and the new IRS Forms 8949 and Schedule D (both revised this year). It's a painless way to learn these important developments and prevent expensive mistakes on tax returns during the imminent tax season. In a concise, engaging overview, our editor-in-chief Bruce Brumberg talks about:

• the expanded reporting on Form 1099-B, and why the reported cost basis may be wrong or omitted
• how to figure out the right cost basis for your stock sales
• Form 8949 and how to report stock sales on it
• how to interpret Form 1099-B when completing Form 8949
• what to do when the cost basis in Box 3 of Form 1099-B is too low or not given
• totaling the reported stock sales on the revised Schedule D

Try it! It's fun, it's informative, it's just eight minutes long, and you can watch it right here on our YouTube channel:

The video can also be licensed and customized to fit your stock plans, as can any content on myStockOptions.com. If you're on the go and can't watch, you can still download our podcasts on tax return topics and listen to them at any time.

Annotated Sample Forms Show Tax Return Reporting In Detail

Need more on tax returns involving sales of stock acquired from equity comp? Our special section Reporting Company Stock Sales presents FAQs with annotated diagrams of Form 8949 and Schedule D. Each FAQ explains and illustrates a different reporting situation involving stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, or stock appreciation rights. Clear instructions and diagrams show how to complete the forms, whether the cost-basis information on Form 1099-B is accurate, too low, or omitted.

Discounted Stock Options Hit With Section 409A Surtaxes

A recent summary judgment decision, in Sutardja v. United States (Federal Claims No. 11-724T 227-13), makes it clear that discounted stock options face the draconian penalties of IRC Section 409A. The ruling upheld the IRS assessment of a 20% surtax plus interest on income the plaintiff received at option exercise under deferred compensation arrangements found to be noncompliant with 409A. The amounts in dispute total $3,172,832, plus another $304,456 in interest. While in this challenge to the IRS assessment the court still must decide whether discounted stock options were actually granted, it brushed off all the plaintiff's legal arguments claiming that Section 409A does not apply to discounted options.

This case drew attention in a few different law firm blogs. These included Benefits Notes by Leonard Street & Deinard, where attorney bloggers discussed the case on March 7 and again on March 12. As the attorneys warn, the IRS is strictly enforcing the Section 409A rules in examinations of employers. Unless discounted options are structured to be exercised only on a fixed date or upon an allowable 409A event, the law firm urges companies to use one of the safe harbors in the regulations on setting exercise prices. It also warns executives that "they can be the ones who suffer even if they are not the ones who set the discounted price for the options."

In an alert on March 21, the law firm Morgan Lewis examines some implications of the decision. In their view, the case symbolizes the need for careful attention in determining and documenting how the fair market values of options are determined—at the risk of dire tax consequences. The firm also notes that the plaintiff, a co-founder of a now public and successful semiconductor company, "may still prevail" in the trial to determine whether the options were discounted when the company was private, so additional developments in this case "merit watching."

In his Executive Compensation Blog (Mar. 26), comp and benefits attorney Michael Melbinger of Winston & Strawn criticizes the IRS decision to bring the case, given the common stock option grant practices at the time of the disputed activities. He feels "it is extremely disappointing that the IRS would demand penalties under the facts and timeline in this case."

For additional information on discounted stock options, see the related FAQ on myStockOptions.com. See also myNQDC.com, our sister website on nonqualified deferred compensation, for details on IRC Section 409A.

How To Correctly Report Stock Sales On Form 8949 When The Basis Is Wrong On Form 1099-B

Whether you are completing your tax return yourself or are using a professional preparer, you want to review the forms upon their completion to ensure that stock sales are accurately reported. As we explained in earlier blog posts on the revised tax forms and on cost-basis reporting, the new IRS Form 8949 is where you now list the details of each stock sale, while the revised Schedule D is where you now merely aggregate the column totals from Form 8949 to report your total long-term and short-term gains and losses. From our interpretation of the forms, along with the instructions for Form 8949 and the instructions for the revised Schedule D, myStockOptions.com recommends the following steps to avoid overpaying taxes if the wrong cost basis was reported to the IRS on Form 1099-B.

While you still report that cost-basis number from the 1099-B in column (e), you can avoid overpaying your taxes by taking the following steps:

1. Start with Part 1 on Form 8949 for short-term capital gains/losses or Part II for long-term capital gains/losses. Box 1c on Form 1099-B (or the reformatted substitute statement from your broker) will indicate which you have (long or short). Towards the top of Form 8949, check either Box (A) or Box (B) according to whether a basis for the stock you sold was reported at all to the IRS.

2. You do not modify the basis number provided to the IRS. Instead, find the column entitled Adjustments to gain or loss, which is column (g). On Form 8949, enter in this column the stock compensation that was not included in the cost basis (Box 3) reported to the IRS on Form 1099-B. This will be a negative number (in parentheses), as the incorrectly low basis reported on Form 1099-B will have made your gain too large (or your loss to small).

3. In addition, you need to add a Code B in column (f) that explains why there is an adjustment in column (g).

4. When the basis is not reported at all to the IRS (i.e. the relevant space on the form is blank), you must report the correct basis in the appropriate column on Form 8949, with no adjustments or codes in the other columns.

For more details on these steps, see the FAQ on this topic at myStockOptions.com. For annotated diagrams showing how to report stock sales from all types of stock compensation, including stock options and restricted stock units, see also our special section Reporting Company Stock Sales.

Big Tax Changes In France Affect Stock Compensation

The election of a new government in France last year has had a major impact on the country's tax landscape, and stock compensation has not escaped. Enacted on December 30, 2012, the French Finance Act of 2013 significantly changed the taxation of qualified stock options and RSUs granted on or after September 28, 2012. For these grants, income received at exercise/vesting is taxed at progressive rates of up to 45%, though the payment of this tax is deferred until the sale of the shares. In addition to the payment of income tax at sale, however, any appreciation in share value after exercise is also subject to progressive income tax rates up to the maximum of 45% plus additional social taxes of 15.5%. This tax treatment is effective from 2013 onward for all sales, regardless of the date when the underlying equity award was granted or the date when the shares were acquired.

However, holding the shares after acquisition can help reduce the capital gains tax at sale. For capital gains on shares that have been held for two years or longer, a progressive tax rebate is available on the following scale:

• 20% rebate for shares held between 2 and 4 years
• 30% rebate for shares held between 4 and 6 years
• 40% rebate for shares held longer than 6 years

Note that the rebate applies only to the income tax portion of the tax on capital gains. It does not apply to the social taxes.

Other recent tax developments in France that may affect mobile employees with equity awards include the following:

• In 2012, France introduced a new surtax on all forms of yearly income, including equity award gains at exercise/vesting, dividend income on shares, and capital gains at the sale of shares. For a single taxpayer with annual income above €250,000 (for joint filers, €500,000), the surtax is 3%. For a single taxpayer with annual income above €500,000 (for joint filers, €1 million), the surtax is 4%.
• With effect from January 1, 2013, a wealth tax applies to any French tax resident with net assets worth at least €1.3 million. If the wealth tax is triggered, the first €800,000 of net assets is exempt. Beyond that point, the tax rate ranges from 0.5% (on net assets between €800,000 and €1.3 million) up to 1.5% (on net assets worth more than €10 million). Wealth tax and income taxes are capped at 75% of an individual's worldwide net income during the preceding tax year.
• The rate of the French exit tax has changed. The exit tax applies to people who (1) have been tax residents of France for at least six of the ten years before the exit date and (2) either hold shares worth over €1.3 million or own at least 1% of financial rights in a company that is subject to corporate tax. The taxable moment is the date before the date of departure from France. Latent capital gains are taxed as if the assets were sold on that date. For people who ended French tax residency before September 28, 2012, the rate of exit tax is 19%. For departures that occurred at any time on or after September 28, 2012, through the end of 2012, the rate is 24%. From January 1, 2013, the exit tax is assessed at normal progressive tax rates up to the maximum of 45%.

For more on the complex taxation of stock comp in France, and on the taxation of equity awards in over 30 other countries around the world, see the Global Tax Guide at myStockOptions.com.

Cost-Basis Reporting For Stock Sales On Form 1099-B Affects Reporting On Form 8949

As we explained in our prior blog post, IRS Form 1099-B and IRS Form 8949 have changed for this tax-return season. To recap, Form 8949 is where you list the details of each stock sale, using the information on Form 1099-B. Meanwhile, the revised Schedule D now simply aggregates the column totals from this form to report your overall long-term and short-term capital gains and losses. All of these forms work together, though confusion can arise if Form 1099-B is incomplete or inaccurate.

One point involving these forms is particularly noteworthy for error prevention. The cost basis (also called the tax basis or simply the basis) is the all-important number you subtract from your proceeds to determine your gain or loss. If this is wrongly reported on Form 8949, you may end up overpaying taxes. It is important to be aware that the cost-basis information sent to the IRS in Box 3 of Form 1099-B may be too low, or the box may be blank. Depending on your situation, this may be the case for any of several reasons:

• The new rules for cost-basis reporting are mandatory only for stock acquired in 2011 and later, so the basis of stock acquired earlier may not be reported.
• Brokers are not required to include the compensation part of the basis in their reporting to the IRS, though they can include it on the substitute statement sent to clients. The latest IRS proposed regulations indicate that brokers may not have to report the compensation portion at all in the foreseeable future.
• No basis is reported for restricted stock and RSUs, as they are not acquired for cash and are considered noncovered securities.

When the basis on Form 1099-B is too low, you need to make an adjustment in the gain/loss column on your Form 8949, among other steps. When the basis is not reported at all to the IRS (i.e. the relevant space on the form is blank), you must report the correct basis in the appropriate column on Form 8949, with no adjustments. See our FAQ for details on how to handle Form 8949 when the cost basis on the 1099-B is wrong or omitted, and see also the new FAQ on the compensation/W-2 income part of the tax basis.

Alert: It is up to you—not your company, your broker, or the IRS—to make any necessary modifications in your Form 8949. On myStockOptions.com, the special section Reporting Company Stock Sales presents FAQs with annotated diagrams of Form 8949 and Schedule D. Each FAQ explains and illustrates a different reporting situation involving stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, or stock appreciation rights. Clear instructions and diagrams show how to complete the forms, whether the cost-basis information reported to the IRS on Form 1099-B is accurate, too low, or omitted.

Tax Return Reporting For Company Stock Sales: What's New This Tax Season

Following last year's major changes in tax reporting for stock sales, a few noteworthy changes in the related tax forms were made for 2012 tax returns to be filed in 2013. While not nearly as sweeping as last year's shifts, the alterations are nonetheless important for reporting your stock sales of 2012 on the tax return you file this year.

Changes In IRS Form 1099-B

Sent by brokers by mid-February, IRS Form 1099-B, or the broker's equivalent substitute statement, now includes not only the gross proceeds from stock sales but also:

• their cost basis (also called the tax basis)
• the date when the shares were acquired
• whether gains or losses were short-term or long-term

The information is sent both to you and to the IRS, though your broker may give you more details than it provides to the IRS. While the Form 1099-B for the 2012 tax year is similar to the 2011 version, there are some important differences:

• The box for type of gain or loss, with checkboxes for short-term and long-term, is now Box 1c instead of the former Box 8.
• Box 6 now includes a checkbox for "basis reported to the IRS" along with a checkbox for "noncovered security." According to the form's instructions, your broker can report the basis for a noncovered security.

In general, for people who sold shares acquired through equity compensation, these stock sales carry an extra twist in their cost basis. In fact, cost-basis reporting is now more complex, confusing, and vulnerable to errors. If you are not aware of the reporting rules, the resulting confusion may lead you to overpay taxes. An article and an FAQ at myStockOptions.com explain the background, how to understand Form 1099-B if you sold shares from stock compensation or an ESPP, and how to avoid mistakes with the cost basis that can lead to overpayment of taxes.

Changes In IRS Form 8949

The revision of Form 1099-B last year required a complete revamp of the tax-return forms used to report stock sales. To report a sale of shares on your tax return, you must complete the new IRS Form 8949 along with Schedule D, which significantly changed last year upon the introduction of Form 8949. You submit both with your Form 1040 tax return.

Introduced for use in 2012 (for 2011 tax returns), Form 8949 was revised for 2013 (for 2012 tax returns) by the shifting of a few columns. The all-important column for reporting the cost basis is now column (e), as the prior column (b) for the code that explains any adjustment was moved next to column (g), where you put any adjustment in the gain/loss. In addition, a new column (h) was added for the total gain/loss for each listed transaction. Schedule D, on the other hand, has not meaningfully changed this year.

In the Tax Center at myStockOptions.com, the special section Reporting Company Stock Sales presents FAQs with annotated diagrams of Form 8949 and Schedule D. Each FAQ explains and illustrates a different reporting situation on tax returns involving stock options, restricted stock, restricted stock units, performance shares, employee stock purchase plans, or stock appreciation rights. Clear instructions and diagrams show how to complete these tax return forms, whether the cost-basis information reported to the IRS on Form 1099-B is accurate, too low, or omitted.

The Alternative Minimum Tax Calculation: Major Changes Under New Tax Law

While the American Taxpayer Relief Act (ATRA) did not end the alternative minimum tax (AMT), it has three provisions with a major impact on the AMT calculation. These are important for high-income taxpayers—particularly those who exercise incentive stock options.

1. ATRA set the AMT income (AMTI) exemption amounts for 2012 at $50,600 for single filers and $78,750 for married joint filers. It also permanently indexed the AMT income exemption amounts for inflation in future years (this had never been done before). From 2013 onward, the AMT income exemption amounts will be automatically raised slightly each year in accordance with inflation. The exemption amounts for 2013 are $51,900 and $80,800, according to IRS Rev. Proc. 2013-15 (see page 8).
2. The law indexed the income thresholds where the phaseout of the AMT income exemption begins (the first time this has ever been indexed). AMTI exemption amounts are phased out by 25 cents for every dollar of AMTI over specified exemptions. In 2013, for married joint filers the phaseout range starts at $153,900 of AMT income; for single filers, the phaseout starts at $115,400 of AMT income. Therefore, in 2013 the exemption is fully phased out when AMTI is equal to or exceeds $477,100 for joint filers and $323,000 for single filers.
3. Achieving yet another first, ATRA also indexed the income threshold where the 26% AMT rate ends and the 28% AMT rate begins. In 2013, for unmarried single filers and married joint filers alike, this threshold is $179,500; for married people filing separate returns, the threshold is $89,750.

The permanent indexing of the AMT income exemption amounts for inflation was an important development. Before ATRA, Congress had enacted temporary AMT relief every year for several years as a stopgap measure to keep middle-income people from being unfairly hit by the AMT. This worked as an interim measure, but the annual process in Congress for passing each patch was tortuous, politically charged, and full of uncertainty. Eventually, there was a consensus that the matter was too important to be left to last-minute legislative activity every year. Without annual increases to control the spread of the AMT, the AMT exemption amounts would have returned to the low levels of 2000 ($45,000 for joint filers and $33,750 for singles), imposing the AMT on a vast population of middle-income taxpayers it was never intended to tax. By essentially automating the annual AMT patch, the inflation-indexing of the exemptions obviated the former annual need for Congressional action and eliminated the related yearly uncertainty.

Even if, after these three changes, you are still stuck with the AMT, there are planning techniques that can help. See FAQs on myStockOptions.com about how to minimize AMT liability, or how to manage it if you know you must pay it.

Tax Act's Effects On Nonqualified Deferred Compensation

For nonqualified deferred compensation, the subject of our sister website myNQDC.com, the American Taxpayer Relief Act has some impacts. In general, these make it more appealing than ever to defer income into the future through nonqualified plans. The following potential tax increases apply to nonqualified deferred compensation with effect from January 1, 2013.

• The top federal withholding rate on supplemental income rose to 39.6%. The withholding rates on supplemental income apply to current and former employees at the distribution of deferred compensation. The higher of two flat federal rates for withholding from supplemental income changed under the new tax law, as the rates are tied to income tax brackets. For aggregate supplemental wage payments totaling up to $1 million during the year, the rate is unchanged at 25% (the rate of the third income tax bracket). For aggregate supplemental wage payments that exceed the level of $1 million in a calendar year, the rate is now 39.6% (the new rate of the highest income tax bracket).
• The Social Security rate returned to 6.2%. At the time of your compensation deferral or the vesting of a company match or contribution, you pay Social Security tax. In 2013, the Social Security tax rate returned to 6.2% from the reduced rate of 4.2% that applied in 2011 and 2012, as the new tax law did not extend the reduction in payroll tax. Social Security tax applies up to a certain amount of yearly income ($113,700 in 2013) and not to yearly income above that threshold.
• At deferral or vesting, you also pay Medicare tax. Separately from the American Taxpayer Relief Act, in 2012 the Affordable Care Act increased the Medicare tax rate on compensation income for high-income taxpayers from 1.45% to 2.35%. In addition, a new 3.8% Medicare surtax now applies to investment income, such as capital gains from stock sales, though it is unlikely that this 3.8% surtax will apply to distributions from nonqualified plans. Both of these tax changes became effective on January 1, 2013.

Advantages Of Nonqualified Plans

Generally, the rise in tax rates increases the attractiveness of deferring income into the future through nonqualified plans.

• Deferrals can keep your yearly taxable income below the thresholds for the new top tax rates on ordinary income (39.6%) and capital gains and dividends (20%). These top rates are triggered for single filers with yearly taxable income of more than $400,000 and for married joint filers with yearly taxable income of more than $450,000.
• Deferrals can also lower your modified adjusted gross income (MAGI) below the thresholds for the increases in Medicare tax detailed above. These new Medicare tax provisions apply to single filers with yearly MAGI of more than $200,000 and to married joint filers with yearly MAGI of more than $250,000.
• Deferrals can help to keep your adjusted gross income (AGI) below the threshold for phaseouts on personal exemptions and itemized deductions, which under the new law have returned for single filers with AGI of $250,000 and married joint filers with AGI of $300,000.

Each person's situation is different, however, and you should make projections involving various factors:

• your calculation of current and future tax rates for both ordinary income and capital gains
• the investment return on the compensation you defer
• the growth of alternative investment(s) for the after-tax amount of the compensation without deferral

To make simple projections with these factors, try the calculator at myNQDC.com.

As explained in an FAQ at myNQDC.com, even though you may want to defer this year's expected income into the future, when your tax rates may be lower, you cannot change your deferral election for this year's compensation. Similarly, given the restrictions on redeferrals, you cannot move an income distribution that is scheduled for this year.

Effects Of The New Tax Law On Stock Compensation

Among all of its provisions that took effect on January 1, the American Taxpayer Relief Act does not have any that directly relate to stock compensation—though, of course, increases in the rates on income tax, capital gains, and dividends indirectly affect the value of equity awards. The following changes in tax rates under the new legislation apply to income from stock option exercises, restricted stock and RSU vesting, ESPP purchases, sales of stock, and dividends. (See FAQs at myStockOptions.com that show the taxes and withholding rates for various types of equity awards.)

• The top federal withholding rate on supplemental income rose to 39.6%. Supplemental income, such as stock compensation, is subject to one of two flat rates that are linked to income tax rates. For aggregate supplemental wage payments totaling up to $1 million during the year, the rate is 25% (the rate of the third income tax bracket). For aggregate supplemental wage payments that exceed the level of $1 million in a calendar year, the rate is now 39.6% (the new rate of the highest income tax bracket).
• The Social Security rate returned to 6.2% after a temporary cut to 4.2% in 2011 and 2012, as the new tax law did not extend the reduction in payroll tax. Social Security tax applies up to a certain amount of yearly income ($113,700 in 2013) and not to yearly income above that threshold.
• The capital gains tax rate that applies to the proceeds from a stock sale increased to 20% for single filers with yearly taxable income of more than $400,000 and for married joint filers with yearly taxable income of more than $450,000. (For taxpayers whose yearly taxable income is below these thresholds, the top rate of capital gains tax remains 15%.)
• Similarly, the tax rate on dividends grew to 20% for single filers whose yearly taxable income is over $400,000 and for married joint filers whose yearly taxable income is over $450,000. This applies to any qualified dividends received on company stock you own or on unvested restricted stock for which you have filed a Section 83(b) election.
• For people with incentive stock options, the income exemption amounts (commonly known as the "AMT patch") for calculating the alternative minimum tax in 2012 are $50,600 for single filers and $78,750 for married joint filers. Additionally, the new tax law indexed the annual AMT income exemption amounts permanently for inflation. The new tax legislation did not extend the refundable AMT credit that was available for the tax years 2007 through 2012.
• Separately from the American Taxpayer Relief Act, in 2012 the Affordable Care Act increased the Medicare tax rate on compensation income for high-income taxpayers from 1.45% to 2.35%, and a new 3.8% Medicare surtax now applies to investment income, such as capital gains from stock sales. Both of these tax changes became effective on January 1, 2013.

Financial Advisors Present Year-End Ideas And Strategies For Stock Options And Company Stock Holdings

Year-end planning can be tricky, and it has never been more so than now, amid the tax-rate uncertainty that hangs over the close of 2012. To explore the issues in a helpful way, we asked six leading financial advisors to provide some ideas on financial and tax planning for stock options and company stock holdings at year-end 2012 and beyond. Published in their own words, their comments are presented in an exclusive new article at myStockOptions.com that is available free to all site visitors. (Be sure to peruse the advisors' ideas soon—only three business days remain in 2012!)

Some of the planning ideas from the advisors:

• Your analysis should not only include projections as to the difference in tax rates between 2012 and 2013 but also consider the stock-price-appreciation prospects of the company.
• In a rising-tax-rate environment, you need to weigh the potential benefit of deferring taxes for as long as possible against the cost of paying taxes at a higher rate in the future. This could lead you to sell your stock now and then repurchase it to reset the basis.
• You can accelerate NQSO income into 2012 but keep the time value of the option. It is possible to do this by selling an option into the market that replicates the exercise price and expiration of the NQSO.
• It is best to never let taxes get in the way of achieving financial goals. Tax changes come and go.
• If your stock has been volatile and there is no longer a comfortable spread since you exercised incentive stock options, you may seriously consider taking a disqualifying distribution with ISOs for two reasons.
• Executives contemplating job transitions or retirement during the year ahead should consider the impact on the potential after-tax value of stock awards, especially as a new tax year approaches with so much uncertainty.

For year-end ideas from two other respected financial advisors, see a separate article at myStockOptions.com: Stockbrokers' Secrets (Part 3): Year-End Planning For NQSOs, Restricted Stock, And RSUs.

For still more year-end ideas, see the FAQs in our section on year-end planning.

Impact Of Special Dividends On Stock Compensation

With the prospect of dividend tax rates ballooning from 15% up to a potential 39.6% for high-income taxpayers (plus 3.8% for the Medicare surtax), many companies are making special one-time dividend distributions, as explained in an article at Motley Fool, an online magazine for retail investors. When a company pays a dividend, particularly a large special dividend, its stock value declines by the same amount after the ex-dividend date. Depending on any provisions in the stock plan documents for adjustments in outstanding grants in this situation, these special dividends can affect the value of stock options, restricted stock, and other equity awards.

For shareholders, the stock-value decline from the dividend is offset by the cash they receive. However, while dividends are usually paid on restricted stock, as the shares are outstanding, dividends are not paid to optionholders and are usually not paid on restricted stock units (RSUs).

Companies paying dividends because of the lower tax rate on "qualified" dividends may consider whether this places options and RSUs at a disadvantage (unless they pay a dividend equivalent), and they may want to think about how to adjust for this. As explained in an FAQ at myStockOptions.com, Microsoft did this when making a $3-per-share special dividend in 2004. Many stock plans have provisions that allow for an adjustment or for equity restructurings, such as a special dividend, a stock split, or a spinoff. This is sometimes called an antidilution provision. For additional details, including the accounting treatment, see a recent edition of the newsletter HRS Insight from PricewaterhouseCoopers.

Nonqualified Deferred Comp In Year-End Planning: Can You Change Deferral Elections To Receive Money In 2012, Or Move Scheduled Future Income Distributions Into 2012?

As tax rates are likely to rise after 2012, at least for the high-income taxpayers who typically participate in nonqualified deferred compensation (NQDC) plans, many people are looking at ways to accelerate income into 2012 to get the lower tax rates available now. (Higher tax rates ahead will make nonqualified plans more popular, but that is a blog topic for another day.) It is crucial to understand that NQDC deferrals already made for 2012 income cannot be shifted into 2012. Instead, keeping tax increases in mind, now is the time to focus on deferring 2013 compensation income, as deferral elections for next year must be made before year-end.

Under the rules of Internal Revenue Code Section 409A, one core NQDC concept is that you must make an irrevocable election to defer the income during the year before the year when you earn it and thus would have otherwise received it. Therefore, you are not allowed to change or cancel deferral elections for the current year's income and instead receive the income in that year. This differs from the rules in a 401(k) or 403(b) plan, where you can modify the amount of income for deferral during the year when you are earning it. In NQDC plans, exceptions are made for participants who have just joined the company and for performance-based compensation.

As for shifting future distributions into 2012, this can occur only in very specific situations and depends on your plan. Unless something triggers an early distribution under a specific provision in a nonqualified deferred compensation plan, it is also impossible to move into the current year a payout elected for a future year. If you want to reschedule a distribution, you need to follow strict rules. These force you to make the change at least 12 months before the originally scheduled distribution date, and to redefer the money to a new date at least five years beyond that original distribution date.

The only exception that is under your control occurs with amounts deferred and vested before 2005 in NQDC plans with haircut provisions. Separate from this, an indirect acceleration would be allowed by the Section 409A rules if your distribution were scheduled for January of the following year and your company on its own moved the distribution forward not more than 30 days, to December of the current year. (For more on this very limited situation, see the related FAQ on myNQDC.com, our website devoted to nonqualified deferred compensation plans.)

For the way tax increases may influence your decision on whether and how much to defer, see the articles The Growing Importance Of Nonqualified Deferred Compensation Amid Rising Tax Rates and Advantages To Deferring Income In An Uncertain Tax Environment, also on myNQDC.com.