Incentive Stock Options and the Alternative Minimum Tax 

The second half of the nineteen-nineties saw the rise of the Dot-com industry. Thousands of start-up internet companies or “dot-coms” came into existence. Venture capital flowed freely and it seemed like everyone was snatching up shares in highly-overvalued companies as fast as they became available.

Millionaires were being born overnight and right here in Silicon Valley we found ourselves at the heart of it all. An overwhelming amount of Bay Area companies were offering their employees Incentive Stock Options promising high returns on investment. At the time, it almost seemed a sure bet. Then the bubble burst.

For regular tax purposes, the exercise of an Incentive Stock Option was generally tax-free, provided certain holding requirements were met. For purposes of calculating the Alternative Minimum Tax or “AMT”, however, the excess of the fair market value of the stock on the ISO exercise date over the exercise price was considered income and was reflected in the AMT calculation.

What this meant was that taxpayers in high income brackets ended up with large tax liabilities on income that they had never actually received, since they had not actually sold the stock. Had the market continued on the pace it was on this would not have posed a problem, since the value of the stock likely would have increased and it could eventually have been sold for enough money to easily pay the tax. However, when the bubble burst, most of these securities became worthless or showed a sharp decline in their value.

The result, was that many taxpayers now had a very large tax liability, arising from income they did not and now never would receive. Add to this the fact that penalties and interest would accrue on these liabilities and many taxpayers found themselves selling off their assets or taking out second mortgages on their properties to try to pay their tax bills.

In the wake of all this, a number of affected taxpayers formed a grass-roots group known as “Reform-AMT”. For years Reform-AMT lobbied for legislation providing relief to those affected by the AMT on this phantom income. Then finally in late 2008, amongst a deep recession, housing and credit crisis they scored a major victory.

Among the relief provisions, bail-out’s and tax breaks the Federal Government was busy approving, The “Emergency Economic Stabilization Act of 2008” was enacted providing relief to taxpayers who incurred alternative minimum tax liabilities due to the exercise of incentive stock options.

This is huge news and very welcome relief to those that have been affected. The provision is retroactive. Not only will all debts resulting from the Alternative Minimum Tax on the exercise of incentive stock options be abated, but anyone who actually paid the tax is now entitled to a refund of it.

If you were affected by the AMT tax on incentive stock options the following should make you jump for joy and shed a tear of relief. If you currently owe money because of the AMT on the exercise of incentive stock options: All liabilities associated with Incentive stock option (ISO)-AMT from before January 1, 2008 are abated. You now owe NOTHING!

The IRS has identified taxpayers affected by this recent legislation and generally is not collecting on these accounts, pending recalculation of the taxpayers’ liabilities and abatement of appropriate amounts.

Taxpayers with ISO AMT liabilities that were unpaid as of October 3, 2008, should have received notification of abatement of the unpaid ISO AMT liability. If you believe this applies to you, but you have not received notification from the IRS regarding this liability you should contact our office immediately. We can help you to investigate and resolve this issue as soon as possible.

If you already paid money because of the AMT on the exercise of incentive stock options: Your refund(s) should have been increased by how much you have already paid, including penalties and interest. In 2008, your refund should have been increased by 50% of how much you paid; then again in 2009, your refund should have been increased by 50% of how much you paid.

If you have not already done so, our office can help you to prepare or amend your returns to take advantage of this provision. Contact us to find out how.