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MERLO AGES POORLY

July 18, 2007

The unbroken string of courtroom frustration for AMT-ISO victims continued yesterday in the 5th Circuit Court of Appeals. The appellate panel upheld the Tax Court's ruling that Robert Merlo could not carry back a capital loss on the disposition of stock acquired by exercising incentive stock options.

When you exercise an incentive stock option, the excess of the stock's value over its exercise price is taxable income for computing alternative minimum tax, but not regular tax. If you hold onto the stock for a year after exercise, the excess of the sales price over the exercise price is capital gain for regular tax purposes, and excluded from AMT income to the extent it was recognized on exercise.

Unfortunately for many telecom employees, including Mr. Merlo, stock can decline drastically in value during that one-year period. Mr. Merlo sold his ISO-stock that was worth over $1 million on exercise for less than $10,000. He argued that he should be allowed to carry back his AMT-only capital loss to wipe out his AMT income for the year of exercise.

The Tax Court ruled that the tax law applies the same $3,000 annual deduction limit to AMT capital losses as it does to regular tax capital losses. The appellate panel agreed.

Cite: Merlo, CA-5, No. 06-60723

Link: Prior Tax Update coverage of Merlo.

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