Author: Paul Belfiore

Stock options are a nice way for businesses to offer additional benefits to employees, while providing incentives for when the company does well. Considered as income by the IRS, stock options are subject to taxation. There are two types of stock options that companies may choose to offer employees as an additional form of compensation. These are incentive stock options (ISO) and non-qualified stock options (NSO). The primary difference in these two types of stock options is how they are taxed. ISOs offer the biggest tax advantage. The company issuing the stock option sets determines whether it is classified as ISO or NSO.

A Litchfield resident was about to start a new job where part of her annual compensation would be in the form of stock options. She was unsure of how this would be taxed and sought the advice of the team at Merrimack Tax Associates.

Incentive Stocks Options (ISO) vs. Non-Qualified Stocks Options (NSO) Tax Rules

ISOs are generally not taxed when they are received, however in some cases they may be subject to the alternative minimum tax. When sold, these stocks will be taxed as ordinary income and capital gains for any profit on the investment. NSOs may be subject to your ordinary income tax when they are received. Then when you sell the stock, any profit will be taxed as capital gains. The advantage is clear for ISOs, with a generally lower (if any) tax required upon receipt of the stock options.

The Company Issuing the Stock Determines Whether These Are ISO or NSO

The determination of whether the stock will be issued as incentive stock options or non-qualified stock options decides this based on their compensation strategy and their own tax goals. ISOs can only be issued to employees of the organization. While NSOs can include employees, contractors, advisors, and board members. There is also a limit of $100,000 on ISOs that can be issued to a single employee in a calendar year. Any amount above this and the stock will need to be issued as non-qualified stock options.

It can be tricky to understand how your stock options will be taxed, allowing you to plan ahead for the end of the year. Merrimack Tax Associates was able to give the Litchfield resident a better understanding of how her stock options would be taxed, ensuring that there are no surprises at tax time.

Double taxation occurs when the same income is taxed twice. This most often occurs when income is taxed at a corporate level and then that same income is taxed at an individual level. This is a common occurrence when dividends are paid out. The dividends are earnings that were already taxed to the corporation. When these dividends are paid out to the shareholders, they are then also required to pay tax on the same money that the corporation was already taxed for. It can also be a problem when an income is taxed by two countries, for example where the money is earned and where the earner has citizenship.

Double taxation is a common term that we hear but one that many may not fully understand. An Amherst resident was looking for some clarification about what double taxation refers to and how this can be avoided.

How Dividend Payments Can Fall into Double Taxation

The profit a corporation earns is taxed as income. For publicly traded companies, whatever is left from these profits may be distributed to the company’s shareholders. When these are paid out in the form of dividends, the shareholders are then required to pay their own tax on the income. This money is essentially double taxed, with taxes paid at both the corporate and individual levels.

International Double Taxation

In some cases, double taxation may occur when the money is taxed by two different countries. If the money is earned in one country but the employee legally resides in another, both countries may be entitled to receive taxes on the income. The money is then double taxed by two different countries.

Strategies to Prevent Double Taxation

Setting up the right business structure, LLC, S Corporation, Partnership, and Sole Proprietorship, can allow you to skip the corporate tax. The money would then only be taxed once at the individual level. C Corporations are one of the most common entities facing double taxation, as they are required to pay taxes on corporate earnings.

For those facing international double taxation, the U.S. allows for a Foreign Tax Credit (FTC) on your tax return. This entitles the filer to claim a dollar-for-dollar credit for income taxes paid to a foreign country.

Understanding the scenarios that will leave you most at risk for double taxation will help you to prevent this from happening. The Amherst resident is happy to now have a better understanding of what double taxation is and how to prevent this.

Pensions are a great employer sponsored way to fund retirement. These typically provide monthly payments once you retire, making for an excellent source of income in your golden years in addition to other retirement savings and Social Security benefits. Your pension payments are taxed based on the rules of the state where you live, not where the money was earned. Each state has its own tax rules surrounding pension taxes. The rate of tax that you pay on this money will also vary from state to state, with some states charging taxes on pension income for earners above a set adjusted gross income only. One of the big advantages for residents of New Hampshire, as well as a handful of other states, is that the money from your pension is not taxable.

An Amherst resident was excited to retire from her job with an employer sponsored pension. Not wanting any surprises when it came time to receive the money, she contacted the team at Merrimack Tax Associates regarding questions about how these payments would be taxed.

States with No Retirement Taxes

There are several states that do not tax retirement income, including pensions. In other cases, a state may require a tax on this money only if your income is over a certain level. New Hampshire, a state with no income tax, does not require you to pay taxes on retirement income. This includes Social Security benefits, pensions, IRAs, and 401(k) withdrawals. This is a tremendous advantage to retiring to New Hampshire, and one that can add up to some big tax savings.

In Massachusetts there is a flat rate of 5% tax on retirement income. This does not apply to Social Security benefits, but most pensions are taxable at this rate with the exception of some government and public pensions that may be tax-exempt. IRAs and 401(k) withdrawals are also taxable in Massachusetts.

Other states have their own rules and regulations for taxing retirement income. The Amherst resident was pleased to hear that the IRS would not be taking a chunk of her pension each month for taxes since she was a New Hampshire resident. She can now enjoy the quiet retired life in comfort.

It can be exciting to win anything from a raffle prize to much larger winnings like vehicles and electronics.  However, even these non-cash items that you win are taxed by the IRS.  These items are taxed at your normal tax rate for the estimated value of the item at the time of winning.  In many cases the organization that gives the prize will be reporting your win to the IRS.  Then if you fail to report this on your taxes and thus pay your portion in taxes on the prize, you may find yourself being hit with a penalty and audit from the IRS. 

A Hudson resident was so excited to win a brand-new car in a local giveaway.  However, the shock came when she discovered that she would have to pay taxes on the value of the vehicle.  This added up to a significant amount of money that she had not anticipated owing to the IRS.

Reporting Your Winnings on Your Tax Return

Whether a cash windfall or some other item of significant value, you will need to report this win on your taxes using IRS Form 1099-MISC.  While cash won is very straightforward, taxed at your regular rate, a non-cash win can be a little bit trickier.  The items that you win will be taxed at their estimated value.  For larger items, the amount of tax owed can be quite substantial and burdensome when you have to pay the tax money.  When you win a high-value non-cash item, you will want to make sure you take the tax implications into consideration.

Ways to Reduce the Tax Burden of Your Non-Cash Winnings

Winning is great, but if it isn’t something that you want or need it can feel more like a detriment when you have to pay taxes than an actual win.  If this is the case, you can donate the items to charity.  As long as you are itemizing your deductions, this can then be used as a charitable contribution deduction which will offset the taxes owed on the item.  You can also refuse the prize.  By not taking possession of the item you have won, you will have no tax obligations regarding it. 

If you do find yourself on the winning end of a non-cash prize that is of significant value, it is a good idea to consult a tax professional.  For the Hudson resident, the team at Merrimack Tax Associates was able to discuss the tax implications of her win and the best way to plan ahead so that there wouldn’t be any surprises from the IRS.