INDIVIDUAL
Stock Options and the 83(b) Decision

When an employee receives property, including stock, in connection with the performance of services, IRC Sec. 83 governs how the worker is taxed. Generally, under IRC Sec. 83, an employee includes the fair market value of stock in gross income for tax purposes not when the stock is initially granted, but when the restrictions on the stock are no longer applicable (i.e., when the stock vests). Nevertheless, the employee also has the option of making an IRC Sec. 83(b) Election at the time of receipt, which, in effect, accelerates the moment tax is due—often helping to fix the tax at a lower amount.

Potential for Tax Savings
You may ask, “Why would I make the 83(b) Election and accelerate the taxability of my income?” When made properly, and under the right circumstances, the 83(b) Election can result in significant tax savings, and thus it is worth careful consideration. Under Sec. 83, property is generally taxed as ordinary income to the recipient at its “fair market value” as of the time of unconditional receipt. When property is transferred, but subject to vesting or a risk of forfeiture, the recipient is not considered to have unconditional receipt until the property is vested or the risk of forfeiture is eliminated. Those who make the 83(b) Election do so because they expect that the value of the stock will appreciate during the vesting period, and they desire to pay the tax on the value when the property is first received, not when it vests. The big advantage of the 83(b) Election is that any appreciation in the stock after the date of grant would be characterized as capital gain, not ordinary income, and would only be recognized when the stock is finally sold.

However, keep in mind that there is a downside associated with filing an 83(b) Election. First, you must come up with the cash to pay the tax on the stock grant. Second, there is a risk that the property in question does not rise in value, but rather remains the same or declines. In that case, you owe ordinary income tax based upon the value when the election was filed, but get only a capital loss when you sell. The worst-case scenario would be if the stock never vests. In that case you receive no capital loss and are out of pocket for the tax paid up front. Last, the IRS may challenge the claimed fair market value for the property. For that reason, it is important to have a bona fide independent means to establish or verify the reported fair market value.

When and How to File
The status of the person making the election will determine when you actually pay the tax on the income from making the 83(b) Election. If you are an independent contractor, the tax will be due and payable when taxes for the year in which the property received are due, generally April 15 of the following year. For employees, the employer has an immediate obligation to make a payroll tax payment, and the employee can expect this amount to be withheld from his paycheck.

The time for filing the 83(b) Election is one of the shortest periods under the tax laws. Under Sec. 83(b), a taxpayer has only 30 days from the date the property is received to file the Election. The 83(b) Election is made by filing one copy of a written statement with the Internal Revenue Service. In addition, one copy of the 83(b) Election must be submitted with the income tax return for the taxable year in which the property is transferred, and a copy of the Sec. 83(b) Election must be provided to your employer. As you can see, this is a complex area, and each case should be examined on its own merits by a qualified tax specialist.

For more information, please contact Charlie Pomo at cpomo@gellerco.com.

Estate-Planning Techniques
First in a Series

It is a generally accepted fact that many individuals pay too little attention to how their assets will be distributed after their demise, but a recent survey casts some light on just how widespread a problem this really is. A poll of some 800 affluent adults conducted by PNC Advisors found that more than a third of people with $10 million or more in investable assets do not have wills—the most basic of estate-planning documents. In addition, more than half (56%) of those potentially intestate multimillionaires admitted that the main reason for this glaring deficiency was simple procrastination.

Procrastination Can Cost You
If that is the state of affairs among the well-to-do when it comes to estate planning, it is a safe bet that things are no better—and probably worse—among those of more modest means. It is not surprising that so many people avoid undertaking any discussion that involves contemplating their own mortality. However, such avoidance can be foolhardy, and the potential negative consequences become more severe in proportion to the increasing size of one’s estate. Even in the wake of significant estate tax reform, high-net-worth individuals could risk 50% or more of their assets ending up in the hands of the government rather than their chosen heirs as the result of insufficient or nonexistent estate planning.

In light of that, this is the first in a series of articles on estate-planning techniques that will appear in TaxView over the coming months. The series will start with the basics of estate planning and gradually move on to discussions of more sophisticated issues and techniques.

The Basics: Will vs. Living Trust
The foundation of any good estate plan is a will or a living trust. Either one can function as a legal document and the primary provider of direction on how the property in your estate will be distributed in accordance with your wishes after your death. It can help you provide financial security for your spouse and children, make allowances for special needs (such as health or education) of individual family members and tailor distributions to the varying income needs of heirs. You can also use a will or living trust to appoint guardians for minor children, name an executor who will be charged with carrying out your wishes as stipulated in the document, minimize the impact of taxes and administrative costs and support specific charitable and philanthropic organizations.

A big advantage of a living trust over a conventional will is the ability to avoid the time, expense and public nature of the probate process. To be most effective, a living trust must own all of your assets, although you retain control over them by naming yourself as the trustee, with rights to distribute the assets in whatever manner you choose. Like a will, a living trust is also a revocable document, allowing you to change it as often as you want while you are living and remain competent. Because it can be difficult to remember to transfer all your assets to the living trust as you acquire more of them over time, many estate planners advise that you also have a “pour-over” provision in your will, which transfers any overlooked assets into the trust at the time of your death.

For more information, please contact Tate Elliot at telliot@gellerco.com.

STATE & LOCAL
Seeking a Solution to the Quagmire of State Sales and Use Taxes

The morass of individual state sales and use taxes currently in effect and the lack of uniformity in administrative and compliance procedures have long been thorns in the sides of companies conducting business across state lines. Rapid growth of online commerce and the de facto competitive advantage enjoyed by out-of-state merchants who choose not to collect sales tax on transactions have exacerbated the problem. However, some relief may be on the horizon in the form of the Streamlined Sales Tax Project (SSTP).

By way of background, the U.S. Supreme Court has ruled that states cannot force out-of-state Internet and catalog retailers to collect sales taxes for states in which the companies do not have a physical presence. The Court determined that requiring retailers to keep track of the rules in some 7,500 taxing jurisdictions would be a burden to interstate commerce. However, the Court also acknowledged that consumers still have a responsibility to pay sales tax to the state, even in cases where the retailer is not required to collect it. Legal analysts have also interpreted the ruling as suggesting that Congress is empowered to grant states the authority to require merchants to collect sales and use taxes if sufficient efforts were made to overcome the complex and often arcane rules currently in effect.

The Streamlined Sales and Use Tax Agreement
The National Conference of State Legislators cites research estimating state and local government losses due to uncollected taxes on Internet sales at more than $13 billion in 2001. Barring changes in the status quo, those losses are projected to surpass $45 billion in 2006 and reach almost $55 billion in 2011. In response to that challenge, a group of about 20 states (now grown to more than 40) banded together and formed the SSTP to create a model Streamlined Sales and Use Tax Agreement to substantially simplify state and local sales tax systems. The objective of the Agreement is to make the various state sales and use tax codes look similar to each other, while maintaining state sovereignty over setting rates and bases. The proposed areas of simplification include:

• Uniform product and administrative definitions.
• Standardization for sales tax holidays.
• Amnesty for participating voluntary sellers.
• Uniform rounding codes.
• A single sales tax rate per state, with individual states responsible for distributing to local governments their appropriate share of such taxes.
• Uniform customer remedy and other procedures.

Resolution and Compliance
Legislation to bring sales and use tax codes into compliance with the Agreement has been proposed or enacted in more than 40 states, including New York and Connecticut. At the federal level, Congress has introduced bills in both houses that would grant states the authority to require Internet and catalog retailers to collect state sales taxes. While there has been some resistance to the proposals in the private sector, particularly among fast-growth companies involved in Internet and/or mail order sales in five or more states, the overall response has been positive. A recent survey of senior tax executives at small, mid-size and large private-sector firms found that 74% favored the SSTP Agreement, even though 41% said they expected an initial increase in compliance costs and 37% suspected their tax exposure might increase.

For more information, please contact Carolyn Makuen at cmakuen@gellerco.com.

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The information contained in TaxView is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Geller & Company to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors.