Strike a deal. (StockOptions).

New clients Joe and Jane Bigdebt pay you a visit. They filed their 2000 tax returns late and sent them in without payment. They owe $400,000 in combined U.S. and California taxes, primarily due to their exercise of incentive stock options in 2000. Most of the tax they owe is alternative minimum tax since they didn't sell the shares by Dec. 31, 2000.

Joe and Jane make $200,000 per year. However they are heavily mortgaged and have a $600,000 margin loan. Their stock has dropped from a high of $240 (the day they exercised) to a current price of $1. They want to know what to do. Briefly their options are:

* Apply for an offer in compromise;

* Request an installment agreement;

* Hope for legislative change; or

* Pray the stock price goes up.

OFFER IN COMPROMISE

Jessie Weller, a San Francisco Bay Area IRS spokesperson, notes that the IRS does not have a special procedure to deal with OICs arising from stock options. Offers are considered on a case-by-case basis and granted based upon the taxpayer's ability to pay the deficiency over the maximum 10-year period allowed within the statute of limitations.

The IRS has changed the overall OIC program significantly as part of the 1998 Tax Act to increase efficiency and increase the criteria for acceptance. These changes are detailed at www.irs.gov.

An OIC is time consuming. Although the IRS internal guideline is to complete OICs within six months after submission, it's not currently meeting this goal. However, they have consolidated OIC processing at two service centers to expedite cases.

The Bigdebts may have difficulty having an OIC approved since they have an annual income of $200,000, and it would appear that the deficiency could be paid within 10 years.

CALIFORNIA OICs

The FTB also does not have a special procedure for stock option deficiencies and deals with these matters on a case-by-case basis.

Since many taxpayers have significant assets and the potential to earn high incomes, the FTB allows them additional time to pay the deficiency. The FTB does not require taxpayers to liquidate their stock holdings.

INSTALLMENT AGREEMENTS

A taxpayer may use Form 9465, Installment Agreement Request, to request an installment payment. This form generally is attached to the tax return when filed. The IRS cannot deny the request if the deficiency is less than $10,000 and certain tests are met. The IRS has the Option of accepting the request if the deficiency is between $10,000 and $25,000. If the deficiency is more than $25,000, Form 9465 still may be used to start the collection process.

The IRS does not recommend attaching a Form 433-A, Individual Collection Statement, or Form 433-B, Business Collection Statement, to a tax return. Since the Bigdebts have filed their return, they can contact an IRS collection office, fill out Form 433-A and enter into an installment agreement.

Neither the IRS nor FTB publishes statistics on approval ratings for collection agreements.

PROPOSED LEGISLATIVE CHANGE Congressman Richard Neal (D-Mass) has introduced HR 2794 to provide AMT relief. The bill, which was still in committee in early December, provides that for ISOs exercised during calendar year 2000, the amount of preference for AMT will not exceed the amount that would be computed if the option had exercised using the fair market value on April 15, 2001. If the stock was sold or exchanged before that date, the sale price is used for the computation.

DEFICIENCIES CAUSED BY NQSOs

The proposed legislative changes deal with ISO/AMT deficiencies. However, many taxpayers with significant exercises of nonqualifled stock options have deficiencies as well. Many of these deficiencies are caused by under-withholding on same-day sales. Generally the federal withholding rate is 28 percent; in 2001 the top marginal tax rate is 39.1 percent; and in 2000 it was 39.6 percent. These taxpayers are not given favorable treatment in the proposed legislation.

The Bigdebts' CPA should carefully evaluate and explain the alternatives for dealing with their large deficiency. Although they are not ideal candidates for an OIC, this alternative should be considered carefully. Together with their CPA, the Bigdebts can undertake a proactive plan to deal with their tax deficiency.

Robert M. Caplan, CPA is a partner in the Foster City firm of Caplan & Solon. He is a member of CalCPA's Committee on Taxation