Repurchasing the Same Shares Won’t Allow You to Avoid the Tax Bite on Stock Gains
Q: I have recently become eligible to exercise an option to purchase up to 500 shares of stock in the company where I work, and I am concerned about the tax implications of selling the shares immediately after buying them, as is a common practice. The shares are now worth about twice the price for which I am able to buy them, and selling them immediately would give me a profit of about $11,500. Is there any way I can defer this gain by reinvesting the profits back into the same stock? May I simply repurchase the shares and postpone paying any tax until a final sale occurs?
--G.F.
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A: Your plan won’t work. There is no way to postpone your taxable gain once you sell the shares by repurchasing a like amount of this stock or any other. Perhaps you are thinking of the favored tax treatment afforded holders of investment real estate who may enter into a tax-deferred exchange of property upon the sale of those holdings. But that special favor is not available on sales of stock.
However, reintroduction of the capital gains tax rate in last year’s tax law does offer you one potential tax remedy. If you exercise your option to buy the stock and hold the shares for at least 18 months before selling them, your proceeds would be subject to taxation at the 20% rate. If you hold the shares between 12 and 18 months, the tax rate on the gain would be 28%. But if you sell the shares after holding them for less than 12 months, the gain will be taxed at your ordinary income rate.
However, it is critical that you check with your company to become completely familiar with how it handles stock options, as practices vary among companies.
For example, if your company issues “non-qualified” stock options, the “spread” (the difference between the value of the stock on the day the option is exercised and its exercise price) is generally recognized as ordinary compensation income and is subject to federal income tax withholding and Social Security taxes immediately upon exercise of the option, regardless of whether you sell the shares. If you sell the shares immediately upon exercise of the option, your tax liability is based on the “spread,” which has already been taxed as ordinary income.
However, if you hold the shares after excerising the option, your tax basis in the shares is the amount you paid to exercise the option, plus the income that you recognized when you exercised the option.
The difference between that sum and the price you receive for the shares in the future is then the amount subject to taxation, and the tax rate applied at this point is determined by the length of time you held the shares, as described above.
Again, please check with your employer to learn the complete details of your option plan. They are not all the same. Further, even within the same company, option plans often vary between those offered to executives and those offered to general employees.
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Q: I want to convert my traditional IRA into a Roth IRA this year. I have my funds in a brokerage account, and the stocks have appreciated considerably over the years. In all cases, I have held the shares for more than 18 months. When I convert to a Roth, may I consider the taxable amount I report as a long-term capital gain?
--S.Y.
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A: No. All withdrawals from tax-deferred savings accounts (and a transfer to a Roth IRA is tantamount to a withdrawal for tax-reporting purposes) are considered ordinary income and subject to your ordinary income tax rate, no matter how the funds were invested. Capital gains issues are not considered.
For taxpayers in the higher brackets, this should be one of the most important factors in deciding whether to convert a traditional IRA to a Roth IRA.
If you expect to be in a significantly lower tax bracket upon retirement, you may be better off leaving your IRA alone for the time being and withdrawing the funds incrementally upon retirement when your tax bracket is lower and the tax bite will be less.
For the Record: Last week, an item about a son’s wish to claim his nursing home-bound mother, who has some income from dividends and interest, as a dependent on his tax return contained an error. If the mother’s gross taxable income exceeded $2,650 last year, the personal exemption limit for 1997, she cannot be claimed as anyone’s dependent even if her son is paying more than 50% of her support. Only children under age 19 or children who are full-time students under age 24 may have a gross taxable income larger than $2,650 and still be claimed as a dependent.
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Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail carla.lazzareschi@latimes.com
