T1-M1 Compliance and Tax Planning Consideration

Question 1

what is employee taxation on nonqualified/nonstatutory stock options?

Answer 1

• when readily determinable value ( is selling on established exchange)
  + tax when granted => recognize ordinary compensation income
  + basis of the stock is exercise price (means purchase price) at granted date plus any previously taxed on grant date
  + holding period is exercise date
• when NO readily determinable value
  + tax when exercised
  + basis of the stock is FMV when stock option was exercised
  + holding period is exercise date

*If the option does not meet certain conditions for statutory stock options, it will be treated as a non-statutory option

Question 2

what are types of qualified/statutory stock options?

Answer 2

1. incentive stock options (ISO)
   + an ISO is a right that’s given to an employee to buy employer stock at a discount
   + employee may NOT own > 10% of the combined voting power of the corp, parent, or sub as of the date of the grant
   + must remain employee status 3 months from the date of the grant date
   + must exercise within 10 years of the grant date
   + an employee may exercise up to $100K in a year. exceeds will be treated as nonqualified option
2. employee stock purchase plans (ESPP)
   + an ESPP is a plan that allows employees to purchase employer stock at a discounted price
   + can participate through payroll deductions
   + NOT grant to employee with 5% or more combined voting power
   + available to all full-time employees, except highly compensated or less than 2 years of employment
   + cannot be exercised > 27 months after grant date
   + can acquire the right to purchase up to $25K of stock a year
   + must remain employee status 3 months from the date of the grant date
   + the option exercise price may NOT be LESS than the LESSER of 85% of the FMV of the stock when granted or exercised price

Question 3

what is taxation of statutory stock options?

Answer 3

• generally NO tax of the option as compensation on grant date
• the excess of the FMV of the stock on the exercise date over the purchase price is AMT
• Both options: stock must be held at least 2 years after grant date and at least 1 year after exercise date to receive LTCG treatment

Question 4

what is restricted stock award and its taxation?

Answer 4

• employee receives actual shares
• employee is restricted from selling the stock until vesting date and restriction lapse
• employee recognizes ordinary income for the FMV of the stock on vesting date
• basis is FMV on vesting date
• holding period begins on vesting date
• may elect sec 83(b) election to recognize ordinary income on grant date. Must be made within 30 days when granted and irrevocable

Question 5

what is restricted stock units and its taxation?

Answer 5

• it is not actual shares, but they are a promise to give employees specific number of unrestricted shares of employer stock on vesting date
• no election to recognize ordinary income on grant date

Question 6

what is stock appreciation rights and its taxation?

Answer 6

• employees do not receive actual shares of employer stock
• employees recognize ordinary income for the amount equal to the difference b/w FMV of stock on exercise date and FMV on grant date

Question 7

what is imputed interest and its taxation?

Answer 7

• if a taxpayer makes a below-market-rate loan, the taxpayer must report any foregone interest (difference b/w federal rate published by the IRS and the interest on the loan) from that loan as interest income
• if a taxpayer receives a below-market-rate loan, the taxpayer may be able to deduct the foregone interest, unless it is personal
• loans subject to imputed interest
  + gift loans: between friends and family members
  + compensation-related loans: between employers and employees
  + corporation-shareholder loans
  + tax-avoidance loans
  + loans to qualified continuing care facilities: lend money to care facilities and get no charge of care fees in return
• exceptions:
• if loan amount is $10K or less for the following
  + loans to individuals: loans are NOT used to purchase income-producing assets
  + compensation-related and corporate-shareholder loans: if avoidance of tax is NOT a principal purpose
• government and certain business loans without significant tax effect
  + gift loans to charitable organizations are no more than $250K per year

Question 8

what is taxation of foreign-earned income?

Answer 8

• a taxpayer may exclude from US gross income up to $120K (2023) while residing in a foreign country
• Qualifications for foreign-earned income exclusion: meet 1 of the 2 tests
  + Bona fide residence test: resident of 1 or more foreign countries for entire year. or
  + physical presence test: taxpayer must physically present in 1 or more countries for 330 days

Question 9

what are factors that affect tax planning?

Answer 9

• changes in tax law
• changes in taxpayer’s personal information such as retirement or opening a new business or filing status
• types of income
• changes in tax rates

Question 10

what are adjustment items that decreases or increases AMT?

Answer 10

• 5 timing differences: PANIC
  1. passive activity losses: add back or recalculated
  2. accelerated depreciation (179, Bonus, MACRS):
  + real property: difference b/w regular dep and straight-line using 40 yrs life for property after 1986
  + personal property: difference b/w regular dep and 150% declining balance (with switch to straight-line). if elect 150% dep for regular dep, no AMT adj for 200% declining-balance
  + no adj is required for sec 179
  3. NOL of individual taxpayer must be recomputed
  4. Installment method may NOT be used by a dealer for property sales
  5. Contracts (LT): difference b/w % of completion method and completed method or any other method
• items only increases AMTI:
  1. certain itemized deductions such as state income tax, sales tax, real estate taxes, and personal property taxes deductions
  2. standard deduction

Question 11

what are tax preference items (always add back) for AMT?

Answer 11

1. private activity bond tax-exempt interest income
2. % depletion deduction (excess of adjusted basis of property)
3. pre 1987 accelerated dep on real and leased personal property

Question 12

what is kiddie tax and its taxation?

Answer 12

• tax on unearned income (from dividends, interest, rents, and royalties) of a dependent child under 18 years old or child 18-24 who does not provide over half of his/her own support and a full time student
• first $1,250 is exempt. next $1,250 is taxed at child’s income tax rate. after that taxed at parents’ tax rate

Question 13

what are FSA and HSA accounts?

Answer 13

1. Flexible spending accounts:
   - allows employee to receive a pretax reimbursement for qualified medical expenses and/or qualified dependent care expenses
   - funded through salary reduction (2023 max $3,050)
   - Must use within the plan year. if there is unused money, can either spend by 3/15 next year or carry to next year up to $610 (2023)
2. Health savings accounts:
   - a tax-deferred saving accounts (like IRA) that allows employee to set aside pre-tax money to pay for qualified medical expenses
   - unlike FSA, unused HSA funds are continue to accumulate
   - max contribution is $3,850 for individual and $7,750 for family (2023)
   - withdraws before 65 years old and not used to pay for qualified medical expenses are:
   + includable in gross income; and
   + subject to an additional 20% tax (penalty). no penalty if withdraw after 65 yrs old
   - if taxpayers have Medicare premiums automatically deducted from their SS retirement benefits, taxpayers can reimburse themselves by withdrawing the same amount from HSA

Question 14

what is tax planning implication in itemized and standard deductions?

Answer 14

• itemized deductions includes:
  + medical expenses (in excess of 7.5 % of AGI)
  + taxes (state/local (limited to $10K)
  + interest expense (home mortgage and investment)
  + charitable contributions
  + casualty/theft loss attributable to federal disaster (in excess of $100 casualty and aggregate of the losses exceeds 10% of AGI) - hard to get this
• planning: bunching itemized deductions in 1 year to take higher deduction. Ex: when total itemized deductions is close to the standard deductions, instead of spreading charitable contributions in several years, taxpayers can contribute a large amount in 1 year to take high itemized deduction this year. Next year, when we do not have much itemized deductions, we are better to take standard deductions

Question 15

what can taxpayer avoid penalty of estimated tax payments?

Answer 15

the penalty may be avoid if:
- taxpayer’s filed tax return shows less than $1K in tax owed; or
- taxpayer paid the lesser of:
+ 90% of the CY tax; or
+ 100% of PY tax (110% if PY AGI > $150K)