Practice Focus Areas

DERIVIUM LOANS TAX AUDITS

Isaacson Wilson, P.S. defends Derivium loans tax audits by the IRS. The IRS has targeted taxpayers who have engaged in loan transactions through Derivium Capital by sending them Preliminary Notices, in late January, 2007, stating that the Derivium loan transaction may be a "tax avoidance" device.

The Derivium loan transaction called for clients to obtain a loan equal to 90% of the value of his shares. If the stock went up, the client could get it back by repaying the loan, with interest. If the stock went down, the client could walk away and owe nothing. And, supposedly, the initial loan was not a sale and thus not taxable. However, the IRS claims the Derivium loan transaction is really a taxable sale of securities at the time taxpayers received the proceeds, rather than a bona fide loan. However, clients may have been falsely advised that because the transactions were in the form of a loan, instead of a sale, they were not obligated to report the transactions as sales on their income tax returns. The "loan" funds paid to clients may have been in fact derived from the sale of the client's appreciated assets. Also, some clients were unaware that their "loans" were funded by sales of their securities.

At Isaacson Wilson, P.S., we can defend you against the IRS's claims. We evaluate each loan arrangement based on the financial contracts and the facts and circumstances of each individual transaction. For a private and confidential preliminary meeting please make an appointment with Brian Isaacson.

TAXATION OF STOCK OPTIONS

Isaacson Wilson, P.S. can help you obtain a refund or abatement of taxes incurred in the exercise of employee stock options. The tax consequences of an equity compensation awards can vary significantly depending on the structure of the award. In general, the goal of the award recipient is to defer the tax costs related to the award and maximize the income from the award that is taxable at the long term capital gain rate. Stock options are attractive because it allows the recipient to decide in the future whether and when to pay the purchase price for the award. However, oftentimes the recipient of the stock option reports most or all of his income as ordinary income, even if the option is issued as a tax-favored "incentive stock option" (ISO). Under current federal law effective through 2008, maximum tax rate of ordinary income is 35% and long term capital gains are taxed 15%.

We help clients who have exercised employee stock options to obtain a refund and or abatement of taxes based upon arguments of law relating to alternative minimum tax credits (AMT), stocks exercised by utilizing company debt, insiders subject to Section 16(b) liability, and stocks which were restricted from being traded in any manner.

Tax Treatment of Non-Qualified Stock Options (NSO)

The recipient of a NSO, generally, reports ordinary income upon exercise of the NSO in the amount equal to the excess of the fair market value, at the time of exercise, of the stock, minus the exercise price of the NSO. The recipient receives the stocks with a basis of the fair market value and a holding period beginning from the date of exercise. Therefore, the recipient of NSO, generally, reports the appreciation pre-exercise as ordinary income and the appreciation during the holding period as capital gains.

Tax Treatment of Incentive Stock Options (ISO)

The recipient of an ISO is not taxed upon exercise of the ISO, instead, the recipient reports income equal to the amount received upon disposition minus the exercise price as long term capital gain. Thus, typically, recipients prefer ISO because appreciation both pre-exercise and post-exercise is taxed at the favorable long term capital gain rate. However, ISOs are subject to two restrictions that oftentimes work to remove the tax benefits of an ISO from the taxpayer.

A disposition of the underlying stock before the holding period is a disqualifying disposition and would have the taxpayer report ordinary income at the year of disposition equal to the fair market value minus the exercise price. A disqualifying disposition is when the recipient disposes of the underlying stock either less then two years after the grant of the ISO or less then one year from the exercise of the ISO.

Secondly, the alternative minimum tax affords no special treatment for ISO. Therefore, the recipient includes the spread, fair market value less the exercise price, in its calculation of the alternative minimum tax in the year of disposition. Depending on various factors and the size of the spread, the recipient could be subject to maximum tax rate of 28% for a portion of the ISO's spread in the year of exercise.

In addition to the two restrictions above, an option qualifies as an ISO only if the following criteria are met: "

• The stock option is granted under a plan that specified the aggregated number of shares that may be issued and the class of employees eligible to receive the grants and the plan is approved by the stockholders of the granting corporation within 12 months of the date the plan is adopted;
• The stock option is granted within ten years of the earlier of either the adoption of the plan or the approval of the plan granting the stock option;
• The stock option is not exercisable more then ten years from its grant date or 5 years of the grant date if the recipient holds 10% of the company's stock;
• The exercise price of the stock option is not less then the fair market value of the underlying stock on the grant date;
• The stock option is not transferable by the recipient, other then by will or death of the recipient, and is exercisable only during the recipient's lifetime by the recipient; and
• The recipient is an employee of the granting corporation from the date of the grant until three months before the exercise of the option.

At Isaacson Wilson, P.S., we help clients, who exercised employee stock options, obtain a refund and or abatement of taxes. To discuss the tax treatment of your stock option or restricted stock, please feel free Brian Isaacson directly.

INVESTOR FRAUD LOSS

As part of our business litigation practice at Isaacson Wilson, P.S., we pursue litigation on behalf of investors against brokers, financial advisors, brokerage firms, and investment advisors. Through our investor fraud loss litigation, we have assisted many investors recover losses from stocks, bonds, mutual funds, variable annuities, and other investments as a result of broker or financial advisor misconduct. While each investor loss case is unique, we find that the typical case involves a claim of one or more of the following:

• Unsuitable Investments or Investment Strategies
  • An investment is unsuitable if it is inconsistent with the investor's objectives, and the broker knows or should know the investment is inappropriate for the investor. In recommending investments to investors, a broker should take into consideration the investor's financial circumstances and needs, including their prior investment experience and tolerance for risk.
• Churning
  • Churning occurs when a broker excessively trades, i.e. induces transactions in the account that are excessive in size and frequency in light of the character of the account, for the purpose of increasing his or her commissions, rather than to advance the customer's interests.
• Unauthorized Trading
  • Unauthorized trading occurs when a broker purchases or sells securities in an investor's account without the investor's prior authorization.
• Fraud
  • Our typical fraud case involves misrepresenting fees and costs of an investment, failing to disclose risks and disadvantages associated with an investment or investment strategy, and/or failing to disclose conflicts of interest.
• Breach of Fiduciary Duty
• Broker Neglect
• Failure to Supervise

Most of our investor loss clients are contractually obligated to arbitrate their dispute through one of the securities industry's arbitration forums. As a result, many of our investor loss cases are filed with the Financial Industry Regulatory Authority (FINRA), the largest non-governmental regulator for all securities firms doing business in the United States. The majority of our cases are resolved through direct settlement between the parties or through mediation. For more information regarding loss that you may have incurred as a result of fraud, please contact Mark Wilson.

TAX SHELTER LITIGATION

Isaacson Wilson, P.S. is also actively pursuing civil litigation against tax shelter promoters. The firm recently won a decision in the Ninth Circuit Court of Appeals involving the BLIPS Tax Shelter of Swartz v. KPMG LLP, Ninth Circuit Cause No. 05-035167.

The firm is also actively pursuing litigation involving the Common Trust Fund Tax Shelter. The transaction at issue involves the use of a common trust fund (CTF) that invests in economically offsetting gain and loss positions in foreign currencies and allocates the gains to one or more tax indifferent parties and the losses to another taxpayer. If you have been involved in CTF transactions and have been targeted for an audit, please Brian Isaacson.

Swartz v. KPMG LLP, Ninth Circuit Cause No. 05-35167

T.C. Swartz sold his educational travel business. Swartz was approached by a “Big Four” accounting firm to invest in a tax scheme to shelter a substantial portion of the capital gains on the sale of that business. That firm persuaded Swartz to ignore warnings from his Seattle accounting firm about the plan and to pay enormous fees to the accounting firm, a national law firm, a firm to handle the transaction, and a major international bank to facilitate the scheme. The IRS, however, had already issued a ruling indicating such tax schemes were illegal.

Not surprisingly, the IRS raised concerns about Swartz’s use of the tax shelter. Swartz paid back taxes and interest, in addition to the fees paid to the various firms who created the scheme. Swartz cooperated with the IRS and blew the whistle on these transactions to the United States Senate. The Senate conducted an investigation of such tax transactions and condemned them as illegal in a lengthy report. The United States Government lost billions of dollars in taxes from such schemes.

Swartz filed a complaint against the tax scheme perpetrators in the United States District Court for the Western District of Washington. Without any discovery having been conducted, the District Court dismissed all of Swartz’s claims and prevented him from amending his complaint to state more complete claims against those organizations.

The Ninth Circuit Court of Appeals reversed the District Court’s dismissal of Swartz’s claims. The Ninth Circuit concluded that the District Court properly dismissed Swartz’s RICO and Washington Consumer Protection Act claims, but found the District Court erred in failing to permit Swartz to amend his complaint to more fully pled claims for state and federal securities violations, common law fraud, and civil conspiracy.

This case may affect hundreds of taxpayers across the United States and is the first published appellate court opinion touching upon the legality of such tax schemes.

TAX CONSEQUENCES OF FRAUD LOSS

We also represent clients who have incurred fraud losses in Section 165 transactions. Generally, a reportable Section 165 loss transaction is any transaction resulting in a claimed loss under that section of (1) at least $10 million in a single tax year or $20 million in any combination of years for corporations, or partnerships with only corporations as partners; (2) at least $2 million in any single tax year or $4 million in any combination of tax years for other partnerships, individuals, S-corporations and trusts; or (3) at least $50,000 in any single tax year for individuals or trusts, if the loss is attributable to a Section 988 transaction.

To discuss the tax consequences of your fraud loss, please feel free to Mark Wilson.