Can you clarify the following paragraph from a recent column: "You can make this 83(b) election with your incentive stock options (ISOs) and restricted stock as well. With ISOs, when you early exercise, the spread will be an alternative minimum tax adjustment. Hopefully, the spread is small enough to keep you out of AMT altogether. If you make the election within 30 days of your exercise, you no longer have to follow the ISO rule that says you must hold the stock two years from grant date and one year from the exercise date to get long-term capital gain treatment. As long as you (and the company) stick around for one year, all appreciation is capital gains."

In the stated example, doesn't the employee still have a disqualifying disposition; therefore, all gains are

not

long-term capital gains? In essence, what is your reasoning that "sticking around for one year" exempts the sale of stock within two years of the date of grant from disqualifying disposition status? -- James Reilly

James,

Your question is a good one, and you are right that the employee still has a disqualifying disposition. By making the

83(b) election, the incentive stock option rules don't go away, notes Rande Spiegelman, a senior manager in

KPMG's

investment advisory-services group in San Francisco. But, you no longer have to stress: Since you owe tax on the spread when you disqualify, and, in this case, the spread is negligible -- your taxes for this disposition will also be negligible. And then any upside is taxed at the capital-gains rate.

Here are the ISO basics.

To qualify for the low capital-gains tax rate of 20% -- when you sell your exercised shares -- you must hold your incentive stock options for two years from the grant date and one year from the date of exercise.

If you do not wait these requisite years, you have a "disqualified disposition," according to the technical jargon in

section 422 of the tax code. When you disqualify, the difference between your exercise price and the stock's price at the time of exercise, a.k.a. the spread, is subject to ordinary income tax.

OK. Let's now assume your options plan allows you to exercise your shares early. Since the difference between your exercise price and the stock's current price is zero, you decide to do exercise early because you believe that the stock's going to pop.

In addition, you make the section 83(b) election and notify the

Internal Revenue Service

within 30 days of your exercise that you're doing so. The election allows you to convert more of the stock's future appreciation into long-term capital gains, assuming you stay with the company and hold the shares for at least one year.

A year later, your shares have vested, the stock is way up and you decide to sell. Technically, you have disqualified the position, according to the tax rules. The original spread at exercise is now taxed as ordinary income.

But wait -- there was no spread! So, who cares! And thanks to 83(b) you'll owe long-term capital gains tax on the sale.

What if there is a little spread? "If prospects for stock look great, then it's not a problem," says Spiegelman.

Here's why. Say your exercise price was a nickel and you did an early exercise when the stock was at $5. Let's assume that $4.95 is too small to give you alternative minimum tax nightmares, so you don't owe tax at this point.

You elect 83(b) and notify the IRS within 30 days of your exercise that you're making this election.

The stock zooms to $100 a year later. Your vesting is up and you decide to sell. You now have a "disqualifying disposition" and the spread will be taxed as ordinary income. So you will owe ordinary income tax up to 39.6%, on the $4.95. But thanks to 83(b), you're only paying 20% on the $95.05.

"Tax minimization is not the goal. Maxing your after-tax profits is," reminds Spiegelman.

So while the rules don't go away, the 83(b) election just allows you to care a lot less about them.

Did the IRS Get My Tax Return!

I electronically filed my state and federal returns through TaxCut on April 9. The federal was accepted almost immediately. I'm still waiting on the State of New Jersey. What should I do? -- Jon Zoll

Jon,

Assuming you electronically filed correctly, both your federal and your New Jersey tax returns were transmitted together. TaxCut actually recommends that you e-file this way.

Then your returns were piggybacked and electronically transmitted to the IRS. In this case, your notification of receipt was for both returns. The Service then sent your state return on to New Jersey.

If you got a declaration control number (DCN) indicating your return was accepted by the IRS, make sure you put in on

Form 8453-OL

-- U.S. Individual Income Tax Declaration For On-line Services Electronic Filing

, as well as the New Jersey e-file form and mail them in. It does matter that they're late. "Just send them in," says Don Roberts, spokesman for the IRS.

But if you filed electronically in previous years, you should have gotten an

e-file Customer Number, or ECN. If you filed your tax return using this number, you would not get a DCN. In that case, you're done.

Problems Solved Next Saturday

Mark you calendar. Next Saturday is an IRS Problem Solving Day. I know, try to contain yourself.

But if you have questions or concerns -- especially if you put your 1999 tax return on extension back in April -- you have the opportunity to walk into a local office and get help from a live person for free.

Check out the IRS

Web site or call (800) 829-1040 for office locations near you. It's recommended that you make an appointment to ensure that someone will be available to help you.

Send your questions and comments to

taxforum@thestreet.com , and please include your full name. Tax Forum appears Tuesdays, Thursdays and Saturdays.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.