The bursting of the telecom bubble left victims strewn across the landscape. None got a worse deal than telecom employees who had exercised "incentive stock options" (ISOs).
ISOs were set up to be a better deal than ordinary "non-qualified" stock options. When taxpayers exercise non-qualified options, the difference between the price they pay to exercise the options and the value of the stock is treated as salary, and they pay taxes on it.
Example: A taxpayer owns non-qualified options on 100 shares of stock with an option price of $1. She pays $1 per share to exercise the stock when the shares are worth $10 each. The $9 per share "bargain element", or $900, is added to her W-2 income.
ISOs are different. The taxpayer pays no tax when an ISO is exercised; if the shares are held for a year after exercise, the "bargain element" is taxed on sale as a capital gain.
Did we say "no" tax? That's not quite right. You pay no "regular" tax, but you do have to pick up the "bargain element" as salary in computing alternative minimum tax. And that's where the nightmare begins.
MCLEOD ISOS - A BAD BARGAIN
Ronald J. Speltz, of Ely, Iowa, was earning about $75,000 annually as a senior manager for McLeodUSA. He exercised McLeod ISOs in 2000 with a bargain element of $711,118, resulting in $206,191 of AMT. Mr. and Mrs. Speltz also owed Iowa AMT of $46,792
As many Iowans know, McLeod's stock collapsed. Mr. Speltz found himself with a $206,000 tax bill on now nearly-worthless McLeod ISO shares.
Mr. Speltz paid part of the tax with his 2000 return and borrowed $134,000 from a bank to pay some more; he then entered into an installment deal to pay the rest. He then tried to compromise the remaining $125,000 or so that he owed with $4,457, which was the cash value of a life insurance policy.
The IRS, as is their custom, turned down the offer, saying Mr. and Mrs. Speltz had the ability to pay the full balance, over time.
NO 'ABUSE OF DISCRETION'
Mr. Speltz went to Tax Court. He argued that the IRS "abused its discretion" by refusing his offer. An attorney who has been fighting for other telecom ISO AMT victims joined the case.
Tax Court Judge Cohen yesterday said her hands were tied. Tax Court judges can't overturn a tax assessment just because the tax law is unfair:
Petitioners’ hardship argument is essentially that the
tax liability is disproportionate to the value that they
received from the ISOs and that they have already been
forced to change their lifestyle unreasonably. Although
we sympathize with their situation, this type of hardship
is not unique.
WHERE IS CONGRESS?
As a matter of law, the judge is right. What is baffling is the failure of Congress to deal with this issue. They are the only ones with the authority to fix this mess. Many taxpayers face the same financial disaster as Mr. Speltz. The telecom meltdown is obviously not just an Eastern Iowa problem; ISO AMT victims are strewn up and down Silicon Valley, and everywhere else the bubble burst.
Congress has passed four major tax acts and a number of minor ones since the telecom bust. The American Jobs Creation Act passed last year had goodies for just about any lobbyist worth his Gucci loafers, but no relief for ISO AMT victims. Senate Finance Committee Chairman Grassley, call your office.
Cite: Speltz v. Commissioner, 124 T.C. No. 9
UPDATE: The Speltz attorney responds.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to