AMT Filers May Finally Get Some Needed Relief

The IRS has announced that it will suspend the collection of back taxes from tax filers that have a large AMT liability due to the sale of Incentive Stock Options. Congress is FINALLY working to approve legislation that would help taxpayers who exercised ISOs during the "Dot com" boom and subsequent bust cycle of 2000 and 2001.

Let's take an example to show this point. As part of his incentive package, a mid-level manager of Yahoo receives an option to purchase 1,000 shares of the company at a strike price of $40 a share back in 1999. Quickly, the stock rises and goes over $100 a share by the beginning of 2000. The employee decides to purchase his options at $40. But - rather than immediately sell the stock - he decides to hold on to the 1,000 shares.

Since the stock options are an Incentive Stock Option, the employee has to recognize the unrealized gain on the difference between the option price and the market price at the time the shares were optioned. This means that this mid-level manager now has to pay tax on the $60,000 gain ($100,000 value versus his actual cost of $40,000) - even though he has not sold the stock. Why? The ISO purchase places him in the Alternative Minimum Tax category. Not only that, but Mr. Yahoo Manager isn't eligible for the 15% long-term capital gains rate. He now has to pay 26% of income (or 28% - depending on his income). To make matters worse, this poor fella hasn't even sold the stock yet. He decided to keep it. So, he has to find the cash from other savings to pay the tax. Sound like a disincentive to hold company stock as an investment?

Being a dedicated employee, he hangs on to his stock while watching it fall off its high in January 2000. He becomes anxious but knows the stock will come back. So, when his tax bill comes due on April of 2001 - and this Yahoo employee realizes his tax bill - he realizes he now has to sell the shares to pay the tax. But there's a problem. The stock has declined to $10 a share! This AMT tax filer has watched his stock get decimated and now doesn't even have enough net proceeds from the sale to pay his Alternative Minimum Tax!

Under the provisions of what Congress is attempting to pass, taxpayers that were caught in this unfortunate predicament will not get their AMT completely relieved. However, they will be able to speed up the use of the AMT credits that were generated as a result of these transactions. This, in effect, will provide a "relief" of sorts on subsequent tax bills. Thus, the IRS has decided to hold off on collecting these back taxes until the AMT credit can be recognized.