San Jose CPA - Tax Planning

I own real estate that has decreased in value below what I owe on the property. What will happen if I cannot continue to pay on the mortgage or my lender reduces the loan balance?

The Emergency Economic Stabilization Act of 2008, which was signed into law on Oct. 3, 2008 included a three-year extension of home mortgage debt forgiveness relief. The new law provides assistance to homeowners who have either lost their homes to foreclosure or are trying to save their homes by restructuring their mortgages. Under 2007 tax legislation, taxpayers can generally exclude up to $2 million of mortgage debt forgiveness on their main home. This relief provision had been scheduled to expire at the end of 2009. The new law extends this debt relief provision through the end of 2012.

To understand the importance of this relief provision, one needs to know that a discharge of indebtedness- that is, a forgiveness of debt- generally gives rise to taxable income. Under the law that applied to debt discharges before 2007, there were no special rules applicable to discharges of mortgage debt on the taxpayer's main home.

For example, assume a taxpayer who wasn't in bankruptcy or insolvent owned a main home subject to a $200,000 mortgage debt for which the taxpayer was personally liable. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. If this scenario had occurred in 2006, the debtor would have had $20,000 of debt discharge income. The result would have been the same if the creditor had restructured the loan and reduced the principal amount to $180,000.

Effective for discharges on or after Jan. 1, 2007, the tax law was temporarily changed to allow taxpayers to exclude up to $2 million of mortgage debt forgiveness on their main home. The exclusion applies to debt used to acquire, construct, or substantially improve the taxpayer's main home and secured by that home. Refinanced debt is eligible for the exclusion up to the amount of the old mortgage principal just before the refinancing.

Assume in the example provided above that the discharge occurred in 2007 instead of 2006. In that case, the debtor would have no debt discharge income when the creditor (1) foreclosed with the result that the $200,000 debt was satisfied for $180,000 or (2) restructured the loan and reduced the principal amount to $180,000.

However, this debt relief provision was scheduled to expire at the end of 2009. The new legislation extends the provision through 2012. Apart from providing this three-year extension, no other changes were made to the provision.

My employer granted me incentive stock options as part of my compensation package. I was considering exercising some of my options this year. So what are the tax implications?
When you are granted Incentive Stock Options (ISOs), there is no tax effect for you. When you exercise the options there is no addition to your regular taxable income. HOWEVER (the big caveat), there is an addition to your alternative minimum taxable income. Alternative minimum taxable income is a separate income tax calculation that includes certain items that the regular income tax calculation does not include. One of those items which is included in alternative minimum taxable income and not in regular taxable income is the difference between the market price of stock and the option price of stock on the day the option is exercised. For example, today you exercised 3,000 options which were granted to you through the company's incentive stock option plan. The option price was $1.75 per share (and so you wrote the company a check for $5,250). The market price today was $31.75 per share. You have no additional taxable income for regular tax purposes. You DO however have $90,000 of additional taxable income for alternative minimum tax purposes. If you are considering exercising incentive stock options, it is probably wise to undertake some measure of tax planning in order to gauge the effect of the alternative minimum tax on your overall tax picture. Also be aware of the timing rules related to sale of stock acquired through the exercise of stock options.

What's the difference between Incentive Stock Options (ISOs) and non-qualified stock options?
The primary difference relates to taxation at the date of exercise. Whereas Incentive Stock Options are not subject to regular income tax when exercised, non-qualified stock options are. Note that regular income tax is mentioned. When exercising Incentive Stock Options, attention should be paid to the Alternative Minimum Tax (AMT).

I am considering accepting a new position in California. What will the tax consequences be?
California does have relatively high individual income tax rates (9.3% at the highest). California also has relatively high real estate prices (which leads to some of America's highest mortgage interest deductions). In order to assess the effect of these variables on your financial picture, and whether your new compensation package is adequate, a three to five year tax planning projection compared against your current situation can often be quite valuable. In fact, it may be possible to show from an after tax, cash flow perspective how a higher salary will be required from a prospective employer before a decision is made.

What approach is used in planning for multiple years at the same time?
Tax planning software that handles multiple years simultaneously is used. For example, your decision to sell stock in one year may affect your April 15 tax liability in the next year. That upcoming tax liability may cause you to have to sell stock next year. If you do sell stock, and pay tax, how will that affect your AMT in the following year? An example of a multi-year tax projection can be found by clicking here.

Tax planning is important as a part of your overall financial planning picture. We work with attorneys, CFPs, and other financial and investment advisors to guide our clients. In this economy, we can assist you to protect you and your family's future. .

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