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CONGRESS THROWS BONE TO AMT-ISO VICTIMS

December 09, 2006

We've discussed the disastrous alternative minimum tax consequences that can arise from incentive stock options several times (for example, here and here). The ISO-AMT rules clobbered many employees of telecom and tech companies by leaving them with a big tax liability for the purchase of employer stock that ended up worthless.

The ISO-AMT victims have been pushing for legislative relief ever since. This morning Congress threw them a bone that will allow many taxpayers to recover over the next few years the AMT attributable to their old ISO exercises. Perversely, some taxpayers may have to quit their jobs to cash in.

AMT CREDITS

One of the cruel jokes of the ISO-AMT is that it creates a "minimum tax credit." This credit reduces regular tax - not AMT - in future years, but only by the amount the regular tax exceeds your AMT that year. This amount generally varies between little and nothing for the ISO-AMT victims.

The new law allows individuals with minimum tax credit carryforwards to use a portion of them regardless of whether they would otherwise be subject to AMT, during the six year period starting in 2007. The extra minimum credit allowed under this provision is "refundable," which means that the IRS will issue a check for it even if you have no tax paid in for the year through estimated payments or withholding.

The formula for this credit is confusing and perverse. It works like this, best I can tell:

1. Determine your "long-term unused minimum tax credit" ("LTUMTC"). This is your minimum tax credit carryforward that originated from AMT at least four years earlier. For 2007, that means minimum tax credits from AMT incurred in 2003 or earlier. Note that this applies to AMT credits arising for any reason - though I suspect that most folks with large AMT credit carryforwards are ISO victims.

2. Determine your "AMT refundable credit amount. This the greater of $5,000 (or your LTUMTC, if less than $5,000), or
20% of your LTUMTC.

3. Reduce this amount by a goofy phase-out formula: 2 percentage points for each $2,500 your income exceeds a threshold amount. This eliminates your AMT refundable credit over a $122,500 range. The phaseout ranges for 2007:

                                           Complete

Taxpayer's status               Threshold  phaseout

in 2007                           amount     after

----------------------------------------------------

Married or surviving spouse      $234,600  $357,100

Heads of households               195,500   318,000

Unmarried (not surviving spouse)  156,400   278,900

Married filing separately         117,300   178,550

 

So, if a taxpayer's income is low enough, they can recover their entire AMT liability from their tech stock debacle in 2000-2001 between 2007 and 2012. If they have a good tech job, though, they're still out of luck.

It's not hard to imagine cases where taxpayers will be better off quitting their jobs so they can qualify for the credit. If you have a $400,000 per-year tech job and a $5 million AMT credit carryforward, you would earn more if you quit your job; quitting would entitle you to a $1 million check annually the first year from IRS for your unused minimum credit carryforward.

I love the tax law.

Other coverage of the extender bill provisions:

LAST GOP TAX BILL ADDS HSA IMPROVEMENTS

UPDATE: The refundable credit is computed on a declining balance. In my example above, the maximum credit would be $1 million the first year (20% of $5 million), $800,000 the second year (20% of $4 million), $640,000 the third year (20% of $3.2 million) and so on. Thanks to Kaye A. Thomas, who has an excellent article up about this break.

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