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Filing and preparing taxes for high net worth executives

Preparing and filing tax returns for high net worth individuals who serve as executives in a company or organization presents many challenges and opportunities. These individuals often have a significant amount of their compensation paid in the form of equity and may have alternative forms of investments, multiple homes, and/or unique charitable planning objectives. Keeping in mind some simple dos and don’ts will help ensure that tax filing goes smoothly.


Do analyze the stock option income included in your Form W-2

It is not uncommon for executives to own Non Qualified Stock Options (NQSOs) or Incentive Stock Options (ISOs). The grant of these options is not a taxable event. However, the exercise of the options could have tax consequences.

If an individual exercises a NQSO, he/she must recognize ordinary income equal to the difference between the exercise price of the option and the fair market value of the stock at the time of exercise. This income is reported on a Form W-2 and included in the executive’s wages. The executive should make sure that the proper amount of income was included in his/her wages. As a result of the exercise, the executive’s cost basis in the stock is equal to the amount paid to exercise the option plus the income recognized in the Form W-2. Executives will very often sell the newly acquired stock immediately or shortly after the exercise in order to diversify their investments and/or to pay for the exercise. The executive should make sure that the Form 1099 reporting the sale reflects the proper cost basis.

  • For example: Emily is granted 1,000 options to purchase Castle Corporation stock at $10 per share. Emily exercises the options when the fair market value of Castle Corporation is $50 per share. Emily will recognize $40,000 (($50 - $10) times 1,000 options) of ordinary income and this will be included in her Form W-2. Emily’s cost basis for the 1,000 shares of Castle Corporation stock is $50,000 ($10.00 exercise price times 1,000 options plus $40,000 ordinary income included in her W-2).

If an individual exercises ISOs, there is no regular income to be recognized at the time of exercise, but you may recognize alternative minimum taxable income as discussed below.

Do determine your state income tax filing requirement

If you perform services in a state, you may be subject to that state’s income tax. Many executives travel to different locations to visit different offices or factories. In addition, board members attend board meetings in various states. You should check the income tax return filing requirements for the various states in which you performed services to determine if you are subject to that state’s income tax. You should maintain a contemporaneous calendar and other supporting documentation to prove the number of days spent performing services in a particular state.

Do consider alternative minimum tax

Alternative minimum tax is another part of your overall federal income tax liability. The starting point for computing your alternative minimum taxable income is your federal taxable income with certain items added or subtracted. Three common adjustments are:

  • Taxes – state income taxes and real estate taxes are allowable deductions when computing federal taxable income. These amounts are not deductible when determining alternative minimum taxable income. This could significantly impact one’s alternative minimum taxable income especially for those taxpayers that reside in a high income tax state such as New York, New Jersey and California.
  • Miscellaneous itemized deductions – these items, such as certain legal fees and unreimbursed employee business expenses, are not deductible for alternative minimum tax purposes.
  • Incentive stock options – the spread between the exercise price at the date of grant and the fair market value at the time of exercise is subject to alternative minimum tax even though it is not subject to regular income tax. In addition, special rules must be followed if the stock received through the exercise of the incentive stock option is disposed of within two years from the date of grant or one year from the date of exercise.

The alternative minimum tax is computed on Internal Revenue Service (IRS) Form 6251.

Do get receipts for charitable contributions

No deduction will be allowed for any contribution of $250 or more unless you have a contemporaneous written acknowledgement of the contribution from the donee organization. A qualified appraisal must be obtained for contributions of property whose value exceeds $5,000. Non cash charitable contributions in excess of $500 must be reported on IRS Form 8283.

Do analyze Schedule K-1’s received from alternative forms of investments

Many individuals invest in hedge funds today. Instead of receiving a 1099 that reports the income from the investment, these individuals receive a Schedule K-1. The Schedule K-1 reports all the interest income, dividend income, capital gains income, deductions, etc. that must be reported on the hedge fund investor’s individual income tax return.

Some of these Schedule K-1’s also contain several footnotes that may report information pertaining to foreign investments and may instruct the investor to file Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Companies), Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation), or Form 8865 (Return of U.S. Persons with Respect to Certain Foreign Partnerships) as well as other forms.

It is important to read and fully understand Schedule K-1 and its footnotes. There could be significant penalties if some of the aforementioned forms are not filed.


Do not deduct expenses that have already been reimbursed by your employer

Unreimbursed employee business expenses are deductible by an individual as an itemized deduction to the extent they, along with certain other types of miscellaneous itemized deductions, exceed 2 percent of a person’s adjusted gross income. However, if the expenditure has already been reimbursed to you by your employer it is not allowed as a tax deduction. Check your records carefully to determine what expenses have already been reimbursed.

Do not deduct mortgage interest in excess of the allowable limit

Mortgage interest on debt up to $1 million incurred to purchase, construct, or substantially improve a qualified residence is deductible assuming it is secured by your residence and is recorded. In addition, mortgage interest on debt up to $100,000 that is secured by a qualified residence and used for any purpose is also deductible. A qualified residence is your principal residence and one other property used as your residence, such as a vacation home. Mortgage interest on debt in excess of these amounts is not deductible. If your mortgage balances exceed these amounts, you will need to determine the allowable portion of your mortgage interest under one of several methods.

Do not disregard self-employed health insurance

Executives at entities organized as a partnership or limited liability company may also have an ownership interest in the entity. In that situation, health insurance premiums are considered an adjustment to gross income as opposed to an itemized deduction. Depending on the taxpayer’s self-employment income, the premium cost may be fully deductible instead of being treated as part of one’s medical expenses which are deductible to the extent the total medical costs for the year exceed 10 percent of the person’s adjusted gross income.

Do not underestimate your 2015 estimated taxes

An underpayment of estimated tax penalty will be assessed for 2015 if a taxpayer’s 2015 federal income tax withholding and estimated tax payments do not equal; at least the smaller of:

  1. 90% of his/her 2015 federal income tax, or
  2. 100% (110% if his/her adjusted gross income was more than $150,000) of his/her 2014 federal income tax

Consider your projected 2015 estimated tax liability and determine if you should base your 2015 estimated taxes on your projected 2015 taxable income or your actual 2014 taxable income.

Your state estimated tax payment requirements should also be considered.

Do not overlook the 0.9% Additional Medicare Tax and 3.8% Net Investment Income Tax

The Additional Medicare Tax and Net Investment Income Tax first applied to the 2013 tax year.

The Additional Medicare Tax applies to wages and self-employment income in excess of $250,000 for a married filing joint taxpayer ($125,000 for married filing separately and $200,000 for single and head of household taxpayers). Employers are required to withhold the Additional Medicare Tax once an employee’s wages reach a specified amount. This tax is computed on IRS Form 8959.

The Net Investment Income Tax applies to married filing joint taxpayers whose modified adjusted gross income exceeds $250,000 ($125,000 for married filing separately and $200,000 for single or head of household filers). The tax is equal to 3.8% times the lower of 1) the taxpayer’s modified adjusted gross income in excess of the threshold amounts listed above or 2) the taxpayer’s net investment income.

Net investment income is generally gross income from interest, dividends, annuities, royalties, rents, income from a trade or business which is a passive activity or a trade or business of trading in financial instruments and net gains. The total gross income is reduced by expenses allocable to the gross income that are deductible for federal income tax purposes, such as investment advisory fees, to arrive at net investment income.

The Net Investment Income Tax is computed on IRS Form 8960.

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When preparing and filing tax returns for high net worth executives, care must be taken in order to avoid penalties and minimize one’s tax liability. It would be wise to seek advice from a professional tax advisor given the complex and ever changing tax laws involved.

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Richard J. Bloom, CPA, PFS, MSTPartner

Richard has more than 20 years of experience delivering specialized personal tax and financial planning services to high net worth individuals, including closely held business owners, executives, and hedge fund managers. He provides tax consulti...

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