Tax Update Blog: AMT Archives
FAIR OR NOT, AMT APPLIES
July 15, 2008
So the AMT can make your effective rate on capital gains higher than 15%? Tough, says the Tax Court:
Petitioners' first objection to the application of the AMT is that it contravenes a 2001 statutory enactment of a 15-percent tax rate on capital gains. Petitioners assert that the application of the AMT makes the effective rate on their capital gain income slightly more than 15 percent. In their own words, petitioners contend that the "application of AMT [is] * * * rendered null and void" because of this contravention.
If only it were that easy.
In computing the AMT there is a special computational provision for taxpayers with net capital gains. Generally speaking, the net capital gain income is multiplied by 15 percent and the result is added to the tax on other income which is computed in the manner described above. Sec. 55(b)(3). Following this computational provision, petitioners' AMT is computed at $7,007, which petitioners contend causes their net capital gain income to be taxed at an effective rate slightly greater than 15 percent because of the disallowance of the entire amount of the standard deduction and exemptions.Petitioners' position would require a change to the statute that would apportion the disallowed items. Ultimately, however, respondent's computation is in accord with the statutes, and petitioners' argument fails.
The moral? The tax law is enforced based on what Congress actually did -- not on what you think they were trying to do.
Cite: Fritz, T.C. Summ. Op. 2008-81.
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IRS SNATCHES BACK ISO-AMT REFUND
May 16, 2008
Incentive Stock Options are a textbook case of grim unintended consequences from a tax break. Unlike regular "non-qualified" stock options, ISOs don't generate taxable salary income when they are exercised; if you hold on to them for one year after exercise and then sell them, any gain you have is long-term capital gain, taxed at preferential rates. This is supposed to be a tax break.
But there's a catch: the "bargain element" on the ISOs - the difference between their value and the price paid to exercise the options - IS taxable for alternative minimum tax in the year the option is exercised, even if the stock received on exercise isn't sold. If the stock becomes worthless between the exercise date and the sale date, the taxpayer pays AMT when the stock is exercised, but can only take the loss on the sale to the extent of other capital gains, plus $3,000 per year. Taxpayers have argued that there should be an AMT "net operating loss" rather than a capital loss, so that they could retroactively recover the AMT through an NOL carryback, but the Merlo decision rejected that argument.
The McLeod nightmare ISOs
This problem became all too real for many employees at McLeod Communications in Cedar Rapids -- perhaps most famously, Ronald Speltz.
Another McLeod employee, Bryce Nemitz, attempted to use the NOL carryback argument. Mr. Nemitz sold McLeod stock he had received from exercising ISOs in 2001. McLeod stock had tanked, so he had a huge loss compared to the amount he had to pay AMT on. On an amended 2001 return filed in November 2002, he computed an NOL that he carried back to 1999 and 2000. Things went well at first, as the IRS issued him carryback refunds of $53,942 for 1999 and $1,476,656 for 2000. Then the IRS realized what it had done and asked for the money back.
Did the IRS assess too late?
By the time the case reached Tax Court, the Merlo decision settled the issue of whether a loss on the sale of ISO shares could generate a net operating loss, rather than a capital loss ("no"). Mr. Nemitz tried to save the day by arguing that the IRS had asked for the money back too late, missing the three-year statute of limitations.
The IRS pointed out that assessments can be made on erroneous net operating loss carrybacks, the statute of limitations runs out three years after the filing of the return that generated the loss to be carried back - in this case, the 2001 return, under Code Sec. 6501(h).
Not really an NOL claim?
Mr. Nemitz argued that the refund was governed by Sec. 6501(a), the usual three-year statute of limitations for timely-filed returns, which would have expired for 1999 and 2000 by the time the deficiency notice was issued in 2005. He cleverly argued that since the amount carried back turned out not to qualify as an NOL under Merlo, it wasn't really an NOL, and so it didn't trigger the extended NOL statute of limitations. He also argued that the special NOL carryback statute applied only to regular NOLs, not AMT NOLs.
The Tax Court didn't go for either argument. Regarding the "it wasn't really an NOL" point, the court said:
The record establishes, and we have found, that petitioners claimed a net operating loss, and not a capital loss, for AMT purposes in the 2001 amended return and that they carried back that net operating loss for AMT purposes in the 1999 amended return and the 2000 amended return.
In other words: you claimed it as an NOL and the refund was erroneously issued as a result of the NOL claim, so the NOL statute applies.
Then the court addressed the claim that the special NOL statute only applies to "regular" losses:
As we understand it, petitioners are arguing that, because section 6501(h) refers only to a net operating loss carryback, and not to a net operating loss carryback for AMT purposes, that section does not apply to the deficiency for each of their taxable years 1999 and 2000 that is attributable to the carryback to each of those years of the net operating loss for AMT purposes that they claimed in the 2001 amended return.Section 6501(h) applies in the case of a deficiency attributable to the application of a net operating loss carryback. The only provision in the Code that allows a net operating loss carryback is section 172(b). That section, which is entitled "Net Operating Loss Carrybacks and Carryovers", allows, inter alia, a taxpayer to carry back a net operating loss. Section 172(b) does not refer to, or distinguish between, a net operating loss for regular tax purposes and a net operating loss for AMT purposes. See Plumb v. Commissioner, 97 T.C. 632, 638 (1991). That section provides rules that apply to both the carryback of a net operating loss for regular tax purposes and the carryback of a net operating loss for AMT purposes. .
Like section 172(b), section 6501(h) does not refer to, or distinguish between, a net operating loss for regular tax purposes and a net operating loss for AMT purposes. If Congress had intended that section 6501(h) not apply with respect to the carryback of a net operating loss for AMT purposes, it would have so stated. It did not.
Bottom line: Mr. Nemitz has to pay back over $1.5 million to the IRS, in the hopes of getting some of it back over time under the relief provisions enacted in late 2006 for ISO victims.
The case has a sad note aside from the woeful consequence to the taxpayer; it was one of the last cases argued by our friend Burns Mossman, who died last year. It made me misty-eyed to see his name at the top of the opinion. If Burns couldn't pull it out, I'd say it was hopeless to start with.
Cite: Bryce E. and Michelle S. Nemitz, 130 T.C. No. 9.
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TAX PROCESSING TO START ON TIME FOR MOST TAXPAYERS
December 28, 2007
The IRS has announced that tax processing will start on time for most taxpayers, but that return processing will be delayed for some taxpayers affected by the belated enactment of the AMT patch. Processing won't start until around February 11 for taxpayers with the following forms in their returns:
* Form 8863, Education Credits.
* Form 5695, Residential Energy Credits.
* Form 1040A’s Schedule 2, Child and Dependent Care Expenses for Form 1040A Filers.
* Form 8396, Mortgage Interest Credit.
* Form 8859, District of Columbia First-Time Homebuyer Credit.
Kay Bell and Russ Fox have more.
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PAY EXTRA TAX THIS YEAR? ARE YOU CRAZY?
December 24, 2007
Tax advisors spend a lot of time looking for ways to punt income into the hereafter. It almost feels like heresy to suggest accelerating income. Yet in some narrow circumstances paying extra tax this year can save you money.
One example we see occasionally arises from the way the AMT exemption phases out. For 2007, the AMT exemption is $66,250 on joint returns, but it is reduced by 25 cents for each dollar adjusted gross income exceeds $150,000. This creates a hidden extra bracket for the AMT. While the stated top rate for AMT is 28%, the phase-out makes the real top rate 35% until the entire exemption is phased out (at AGI of $415,000 for joint filers). The phase-out also cause an extra hidden bracket on long-term capital gains, which are otherwise taxable at 15%.
If you have an item of taxable income that you can choose to take in either 2007 or 2008 (lucky you!), you might be better off taking the income this year and paying the tax sooner. It works if:
- Your 2007 income is already above the AMT exemption phase-out amount
- You will be subject to AMT in 2008, and
- Your 2008 income will be in the phase-out range.
A simplified example of an Iowa married couple illustrates this. The couple has $500,000 of 2007 income and will have $200,000 of 2008 income. They have another $100,000 of capital gain income they can choose to take in either year. They have two children, and their only itemized deduction is state income taxes.
If they take the $100,000 in 2007, their combined tax over the two years is reduced by over $6,000; if it is taxed in 2008, it is taxed in the hidden AMT phase-out bracket, while if it is taxed in 2007, it is only taxed at a the normal capital gain rate. The totals:
Be careful! If you are going to accelerate your income, and your taxes, you'd better be pretty confident you know what your income will for both 2007 and 2008. Talk to your tax advisor before you start throwing your income around among your tax years.
This is another in our daily series of 2007 year-end tax planning posts. Look for a new post daily through December 31.
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THANKS, SANTA, BUT GO AWAY
December 20, 2007
If it's true that tax practitioners like new legislation adding complications so that our clients become even more dependent on us, well, our cup runneth over for the holidays. Congress is finishing up five bills to the president this week affecting the tax law in one way or another:
- The AMT Patch
- The mortgage debt forgiveness bill
- The energy bill
- A bill for military tax breaks, with attached technical corrections
- A bill with tax breaks for families receiving funds from the Virginia Tech shootings
The Congresscritters are also working on a farm bill with tax provisions larded in among the New-Deal subsidies that have outlasted the Depression by 67 years now. If they pass it, all tax geeks will need from Santa is a bigger stocking.
The only bad thing about these "gifts" is we can't return them for something useful.
AWFUL TAX POLICY IN SO MANY WAYS
There is so much bad tax policy in these bills, it's hard to know where to start. First, when you change the tax law constantly - six times just this month - that is bad policy by itself. When the law constantly changes, even the most diligent tax professional has trouble keeping up, and the poor taxpayr doesn't have a chance.
The AMT Patch is bad policy spawned by bad policy. The idea of having an "alternative" tax system as a "backup" for the regular system is just a way for politicians to have their cake while eating it. It gives away tax breaks with one hand to buy votes while taking them away with the other to show their concern for the "little guy" who isn't paying income taxes anyway. Rather than enacting a tax law that gets rid of the AMT and deals with the abuses it was supposed to address, the Patch just kicks the problem into next year, where Congress again will flail to deal with it ad-hoc.
The mortgage deadbeat relief bill has the bad policy of treating mortgage deadbeats better than other deadbeats just because they gambled on the real estate market, rather than, say, the stock market or the ponies. It does so temporarily, which is a bad idea, while making the exclusion for home sales (arguably a bad idea by itself) yet more complicated, which is never good. It also moves up part of a 2012 corporate estimated tax payment by one quarter, causing software and administrative complications to "pay for" the deadbeat relief by accelerating tax receipts that would be paid anyway by three months.
The energy bill limits itself to diddling with depreciation lives for some energy assets. The military bill makes the umpteenth change in military tax in the last 5 years, while fixing screw-ups from prior hyperactive tax legislative efforts. And the Farm Bill is just loaded with special interest tax subsidies, paid for by obscure traps and foot-faults and an "economic substance" provision that the IRS and Treasury have always opposed as bad and unecessary, but which the Congressional tax scorers call a "revenue raiser," making it an irresistable "pay-for."
Even the Virginia Tech thing is bad policy. Certainly the families of the victims deserve sympathy, but do they deserve it more than, say, the families Omaha Mall shooting victims? Or the family of the teenager who was stabbed in Des Moines this week? If Congress wants to help murder victims, they should write a tax law treating murder victims right to begin with, rather than narrow publicity stunts to ride the headlines.
IS THERE A SOLUTION?
Advocates of various tax elixirs say their plan will keep Congress from diddling with the tax law. That's fantasy. For example, a 30% national sales tax would make the lobbying game an even more high-stakes field than it is now.
Two things would help things get better. One would be an awareness that every tax break comes with a cost. Each tax break adds complexity and takes money out of the pockets of the majority of taxpayers who don't qualify. If politicians promising tax breaks were properly identified as picking your pockets on behalf of some lobbyist, maybe they'd keep their fingers to themselves.
The other thing that would help would be adults in key policy positions - Treasury Secretary, and chairmen and ranking members of the tax policy committees. If they did their jobs, they would be looking out for the interests of the rest of us against those who are constantly trying to take our money through targeted tax breaks. So much for any hope there.
BLOG COVERAGE OF THE AMT PATCH:
Tax Policy Blog (here and here)
Tax Grrrl
The Wandering Tax Pro
Taxable Talk
The TaxProf.
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HOUSE CAVES, AMT PATCH PASSES
December 19, 2007
The House of Representatives caved this afternoon and passed a an "AMT Patch" for 2007 with no offsetting tax increases. The President is expected to sign the bill.
The House apparently passed the version of HR 3996 passed by the Senate December 6. The bill increases the AMT exemption to $66,250 for a joint return and $44,350 for single filers. The amounts were $62,550 and $42,500 for 2006. If Congress had failed to pass a "patch," the exemptions would have reverted to $45,000 for joint returns and $33,750 for singles, adding an estimated 19 million additional taxpayers to the AMT rolls.
As the patch only covers 2007, it kicks the problem into 2008 - an election year. More fun awaits.
Link: Statement by Treasury Secretary
Related: HOUSE PASSES DOOMED AMT PATCH BILL
UPDATE: The TaxProf has a roundup.
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HOUSE PASSES DOOMED AMT PATCH BILL
December 13, 2007
The House of Representatives yesterday passed an "AMT patch" bill to keep 20 million or so new taxpayers from being hit with the alternative minimum tax. The bill is different from the Senate bill in that it has "pay-fors," or tax increases to generate the same revenue as the pre-patch AMT would. There's no telling how long it will take to reconcile the bills, so the beginning of the IRS 2007 1040 processing season recedes a little further into February 2008.
PAY-GO
The "pay-fors" are the sticking point. Congressional rules have for some years now required tax changes that reduce revenue to be "paid for" by additional revenues from somewhere else. These "Pay-as-you-go," or "Pay-go" rules have generated terrible tax policy and budgeteering chicanery great and small:
GREAT: The entire 2001 Bush tax cut legislation was warped into awful tax policy by the Pay-go" requirements. With enough votes to pass the bills, but without 60 Senate votes to waive the Pay-go rules, the Administration "paid" for its tax rate cuts by leaving the AMT alone. As taxpayers pay the greater of regular tax or AMT, a cut in regular taxes alone mathematically ensures that more people fall into AMT. Ever since then Congress has kicked the day of reckoning down the road one or two years at a time by increasing the AMT exemption amount.
The other great casualty of Pay-go in 2001 was the estate tax repeal. Lacking pay-fors, the 2001 bill increased the lifetime exemption over a period of years until the estate tax was repealed for one year, 2010. The estate tax then roars back in it's pre-2001 form, with top rates over 50%, in 2011. Whether or not you think the estate tax repeal is wise, it's hard to argue that what we have now is sound tax policy.
SMALL: The house-passed bill is full of the little budgeteering chicanery, and bad tax policy, generated by Pay-go. My favorite (via RIA):
Increase for large corporations the required installment of estimated tax which is otherwise due in July, August, or September of 2012 by 52.5 percentage points (with corresponding adjustments to the amount of the next required installment).
This is just a cheesy way to stuff tax revenue from the 2013 fiscal year, which begins in October 2013, into the 2012 fiscal year so they can say that the AMT patch is "paid for" under their through-the-looking-glass scoring rules. That's like "paying" a mortgage payment by taking a cash advance on your credit card.
Who is responsible for the mess? Bob Williams at Tax Vox argues persuasively that there is plenty of blame to go around. The TaxGrrrl just wants the mess cleaned up. And, of course, the TaxProf has a link-rich roundup.
Related: A LATE START TO TAX SEASON?
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A LATE START TO TAX SEASON?
December 03, 2007
The IRS might delay the start of 1040 processing at least two weeks because Congress hasn't passed an "AMT patch" for 2007 yet. Failure to pass the fix would throw 20 million new taxpayers into AMT this year.
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IRS OVERSIGHT BOARD: IRS CAN'T BAIL OUT DAWDLING CONGRESS
November 27, 2007
The IRS Oversight Board says that the IRS can't change it's systems based on what Congress might do to fix the alternative minimum tax. The IRS return processing systems can't be programmed for "what-ifs," according to the board:
These systems can only accommodate one programming option without introducing excessive risk to the filing season. Above all else, the IRS must ensure that its systems can process tax returns under current law. The IRS believes that implementing program changes into these systems that do not reflect current law could jeopardize this responsibility. The Board concurs.
The Oversight Board's views were stated in a letter to Senators Baucus and Grassley, the lead Senate taxwriters.
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PAULSON: PUNT AMT TO 2008
October 04, 2007
It's October. Do you know if you'll pay alternative minimum tax this year?
If you don't know, you're not alone. 23 million taxpayers may or may not be subject to AMT this year, depending on whether Congress enacts another one-year "patch" to put off the day of reckoning.
The 2001 Bush administration tax cuts lowered the regular tax rates for individuals, but not the AMT rates. Also, the AMT isn't indexed for inflation, unlike the regular tax rate system. As you pay the higher of regular tax or AMT, the reduction of regular rates and the effects of inflation have threatened to add millions of taxpayers to the AMT system.
Congress has put off the AMT day of reckoning by passing temporary "patches" that have increased the amount of income exempt from AMT. The most recent of these expired at the end of last year. Unless Congress acts, millions of taxpayers face higher tax bills for 2007.
Yesterday Treasury Secretary Paulson urged the House Ways and Means Committee to pass another patch, according to a story by Tax Analysts ($link). Ways and Means Chairman Rangel has been wanting to craft a bill to permanently fix the AMT by just raising the regular tax -- a proposal that would be certain to draw a veto.
What will happen? I'm guessing another one-year patch. The AMT hits Democratic states the hardest; they tend to have high state income taxes, which are a common cause of AMT. It's hard to imagine Congressional Democrats allowing a big tax increase that hits their own voters going into an election year.
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2008 MALIBU, AURA HYBRIDS QUALIFY FOR CREDIT
September 07, 2007
The IRS yesterday certified the 2008 Chevy Malibu and Saturn Aura hybrid cars for the Alternative Motor Vehicle Credit (IR-2007-156).
Chevy Malibu Hybrid
Saturn Aura hybrid
Both cars qualify for a $1,300 credit. Remember, this credit doesn't work for alternative minimum tax.
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FULL TAX COURT DENIES AMT NOL ON SALE OF ISO SHARES
August 16, 2007
Apparently seeking to be perfectly clear on an an issue that has provoked seemingly endless litigation, the full Tax Court ruled without dissent that a loss on a sale of shares acquired with incentive stock options is a capital loss in computing alternative minimum tax. Capital losses are limited to capital gains plus $3,000, which makes them much less useful than normal operating losses.
Yesterday's decision involved taxpayers who exercised incentive stock options in Veritas Software Corporation. Through March 2000 they paid $175,841 on the exercise to buy shares worth $5,922,522. In computing their regular tax, this generated no income, but the $5,746,681 excess of the stock's value over its purchase price was taxable income for AMT. As a result, the taxpayers paid over $1.6 million of AMT for 2000.
Their stock fared poorly in the subsequent months, and they unloaded 3/4 of their ISO shares for $2,756,758 less than they were worth when they were acquired. Because the acquisition value was used to compute their prior AMT, they had an AMT loss of that amount.
The taxpayers argued that their $2,756,758 loss should be treated as an ordinary loss, giving them a net operating loss for AMT purposes that could be carried back to reduce their 2000 AMT taxable income. The Tax Court instead ruled the loss a capital loss. Assuming that the taxpayer uses the AMT capital loss carryforwards to the tune of $3,000 per year, they should be about used up in a bit more than 900 years.
The result is unsurprising from a technical standpoint, as that is the obvious reading of the law; in fact, it has been reached from a slightly different angle in last year's reviewed Merlo decision (Merlo was affirmed by the Fifth Circuit last month).
The issuance of a fully-reviewed decision is unusual; this is only the fourth such decision this year. Perhaps the court is attempting to chase similar cases off its docket by making clear that further such efforts by AMT-ISO victims are futile.
Congress passed limited relief for AMT-ISO taxpayers last year.
Cite: Marcus, 129 T.C. No. 4
The TaxProf also has coverage.
Related Tax Update coverage:
YET ANOTHER AMT-ISO VICTIM LOSES IN TAX COURT
TAX COURT TO ISO-AMT VICTIMS: YOU'RE STILL SCREWED
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GRASSLEY V. PRIVATE EQUITY
August 10, 2007
Iowa's own Chuck Grassley is looking to private equity funds to fix the AMT mess. It appears that he wants to make public investment partnerships taxable as corporations. It also appears he wants to tax "carried interests" taxable as ordinary income. From the New York Post:
Iowa Senator Charles Grassley said he intends to link his proposal to boost taxes on publicly traded buyout firms to a fix of the alternative minimum tax, a pairing that may make it harder for opponents of the measure to vote against it.
"This is going to come when we deal with the alternative minimum tax," Grassley, a Republican, said in an interview yesterday. He said the bill deals with "issues of equity and fairness."
By going after carried interests, Senator Grassley and other congresscritters divert attention from their own negligence in managing the AMT. Their long-term budget projections assume AMT revenue that they never expect to collect. Increasing taxes on private equity can at best raise only a fraction of the trillion dollars needed to permanently the alternative minimum tax. By itself the annual "patch" to punt the projected expansion of AMT to 23 million more households back another year is now costing $45 billion annually.
If they really want to deal with the AMT, the only way to do so is as part of a broader reform that repeals tax breaks in exchange for lower rates. As it is so much easier to come out against hedge fund millionaires so it looks like you're doing something, that's the course we can expect Congress to take.
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BIG CREDIT, LITTLE CAR
July 26, 2007
The IRS has announced (IR 2007-133) that a $12,000 alternative vehicle credit is available for the hydrogen-powered 2005 and 2006 Honda FCX:
There are only a few dozen of these critters in the wild, and only a few filling stations, so a $12,000 credit might be small consolation for a car that can't be used most places.
Now if hydrogen cars all look like the next version of this car, they might catch on:
Whether hydrogen cars have any real long term potential is another matter. And don't forget that the $12,000 tax credit does not apply for alternative minimum tax.
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SENATOR BROWNBACK AND THE LITTLE GOOD BOOK
July 19, 2007
Kansas Senator Sam Brownback floats a tax proposal as part of his foredoomed presidential campaign. It will land with a thud like a dull axe.
The candidate starts by declaring his undying hatred for the tax law:
People often laugh when I say on the campaign trail that the tax code should be taken behind the barn and killed with a dull axe. In fact, one man in Iowa was so excited by this proposal that he presented me with an axe before I finished my remarks (fittingly, I was speaking in a barn).
He goes on to say that he reads a trimmed-down version of the Bible:
Today's tax code -- which is sixteen times longer than the Bible -- is unpredictable, manipulative and hinders the economic growth that generates more prosperity for all Americans.
Um, no, the Code is not. Like the Bible, it can fit in one volume, but like the good book, it is often broken in two for convenience. That can only mean that the Senator goes with the Readers Digest version of the scriptures.
The Senator didn't come to praise the tax code, but it turns out he doesn't plan to bury it either:
That is why I propose an optional flat tax that would exist alongside the current code. This approach does not gore any of the tax code's sacred cows and it could actually be enacted into law. An optional flat tax would generate economic growth and be vastly more transparent, simple and family -- friendly than the current code.
We already have that. It's called the alternative minimum tax. Unfortunately, it's not optional.
It's hard to picture a less promising approach to tax reform than to start a brand new tax law on top of the old one. In real life, it would mean everybody would do their tax two ways (or three, if you count AMT, which you should).
The tax law needs reform sure enough. The way to do it is to broaden the base by eliminating special interest loopholes and credits, and to lower the rates so people will have less incentive to carve new loopholes. Adding a new code to the old code isn't going to break Senator Brownback from the pack of also-rans.
A recent edition of the Internal Revenue Code. Sam Brownback's version of the Bible is 1/16 as big.
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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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STILL ANOTHER AMT-ISO VICTIM LOSES IN COURT
June 05, 2007
The Court of Claims Federal Claims last week shot down yet another attempt to undo alternative minimum tax caused by incentive stock options.
In March of 2000, Hendy Lund exercised $30,000 shares of Redback Networks, Inc. stock at a cost of $1.1875 per share; at the time the shares traded at about $149.84 each. The $148.6565 per share difference between the market price and the exercise price - the "bargain element" - would be taxable in computing her 2000 alternative minimum tax, to the tune of $4,459,695.
Ms. Lund wisely protected herself by disposing of 11,000 shares of her stock in October 2000 for $1,540,006 ($140/share). By disposing of the shares, she made sure she had some cash to cover her taxes - even though disposing of ISO shares less than 12 months after exercising the option meant forgoing capital gain treatment on the disposition proceeds. Her October sale proved prescient; she dumped the remaining 19,000 shares in April 2001 for $303,984.87 - only $16 per share. Ms. Lund therefore had over $1.8 million available to pay her 2000 and 2001 taxes of about $1.3 million. In contrast, some AMT-ISO taxpayers let their ISO shares decline to almost zero, leaving them without cash to cover their taxes.
The Court of Federal Claims ruled that Ms. Lund could not carry back a capital loss for the 19,000 shares included in AMT income at the $148.68 "bargain element" and sold for $16.00 - a loss totaling over $2.5 million. The tax law limits capital loss deductions to capital gains, plus $3,000, and this limit applies to AMT losses as well as regular tax losses.
The futility of challenging the taxation of the "bargain element" of incentive stock options in the courts seems to have been abundantly established by now. Attempting to use more than $3,000 of AMT losses to offset taxable income is also a lost cause. We probably won't see too many more of these cases, especially now that Congress has enacted relief, however complex and incomplete, for AMT-ISO victims.
Cite: DANIEL D. PIERCE AND HENDY J. LUND, Ct. Claims No. 05-1071T
UPDATE: The TaxProf has more.
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HOW TO SOLVE AMT? FIX THE REGULAR TAX
May 21, 2007
The Tax Foundation has a new study on how to fix the alternative minimum tax. The solution? Fix the regular tax:
More than one quarter of personal income received during 2006 was entirely excluded from the federal individual income tax base. Untaxed government transfers, in-kind compensation of employees, and a plethora of other types of income—none of these is included when the filer tallies his income on his tax form. Another 23.5 percent of personal income was included in the tax base but avoided taxation when filers claimed various deductions, exemptions, credits, and other provisions in the tax code.
If the special interests loopholes and credits (ethanol and biodiesel are only the newest) were repealed, the tax system would raise as much money as it does now with lower rates, less complexity, and without the AMT. Why is it so hard for politicians to do the right thing? From the study:
The logical, preferable alternative to such an administratively redundant tax system would be to repeal all or some of the offending tax breaks from the regular income tax. But each of those special tax breaks has a committed group of champions who fight like dogs to preserve and expand it. In effect, by enacting the AMT and keeping it in law for decades, Congress has recognized that it simply will not repeal tax preferences that benefit politically powerful groups no matter how unjustified those tax breaks are in principle.
That's just as true for special tax breaks at the state level.
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GEE, THANKS, CONGRESSMAN
March 23, 2007
It would be pretty depressing to be in, say, the Polk County Jail. You'd certainly be eager to hear somebody telling you that they could get you out of there. Even so, it's not likely that a transfer to the Warren County Jail would seem like a good solution.
Congressional taxwriters are considering a similar approach to the alternative minimum tax. The AMT is computed with fewer deductions and exemptions than the regular income tax, at a nominally lower rate. It applies when it exceeds the regular tax. As a result of accumulated legislative fudging, the AMT threatens to exceed regular tax for 23 million more taxpayers next year.
Congressman Richard Neal of Massachussets, a Democrat on the Ways and Means committee, has hit on a solution. He proposes raising the regular tax high enough to exceed AMT ($link):
House Ways and Means Select Revenue Measures Subcommittee Chair Richard E. Neal, D-Mass., told reporters March 22 that his efforts to reform the alternative minimum tax will likely involve adjusting tax rates instead of going after preferences in the tax code.
When asked whether an AMT reform proposal would be offset with repeal of tax code preferences or with an adjustment to federal tax rates, Neal replied, "I think that the latter is probably more realistic."
It's reasonably save to assume Congress won't approve this transfer between jails, and if it did, it would almost certainly be vetoed. Congress is instead likely to kick the AMT problem down the road one more year by increasing the AMT exemption temporarily, as they have done for the last several years. Real AMT reform probably requires a 1986-style major tax reform, which doesn't seem to be in the cards.
Related: AMT: THE INCONVENIENT TRUTH
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SATURN AURA QUALIFIES FOR HYBRID CREDIT
March 19, 2007
The IRS announced today that the Saturn Aura qualifies for the Hybrid Car Credit.
Taxpayers buying this vehicle qualify for a $1,300 credit, unless they are alternative minimum tax-payers, who get diddly. Which makes some people grumpy.
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LEGAL FEES AND EMPLOYMENT LITIGATION
March 13, 2007
The tax law draws some distinctions between employees and the self-employed that seem completely whimsical. Sometimes these work out in favor of employees - for example, employees get to exclude fringe benefits that get taxed to the self employed. But some of the breaks cut in favor of the self-employed.
One area where the self-employed get treated better came into stark focus in the tax court yesterday. Philip Chaplin worked as a professional fiduciary with trust company Rice, Heard & Bigelow in Massachusetts. Mr. Chaplin got crossways with RHB and went to work for another company. Lawsuits followed, and Mr. Chaplin paid legal fees of $84,542.
Mr. Chaplin deducted the legal fees as if he were a sole proprietor, rather than an employee. If you are a sole proprietor, you can deduct all of your business expenses, including legal fees, "above the line." If you are an employee, in contrast, you have to take legal fees of employment lawsuits (other than civil rights suits) as "miscellaneous itemized deductions." Miscellaneous deductions are deductible for regular tax only to the extent they exceed 2% of your adjusted gross income; they are not deductible at all in computing alternative minimum tax.
The IRS disagreed with Mr. Chaplin; they said that the expenses were employment-related, rather than for a sole proprietorship. The taxpayer made a spirited argument that his role as a professional fiduciary meant he wasn't really an "employee" of RHB, but he wasn't able to even convince the tax court to waive penalties. The result? AMT of $21,082 and accuracy-related penalties of $4,837.
Unfortunately for Mr. Chaplin, his lawsuit didn't have any wrongful discrimination allegations. If you prevail on an employment discrimination lawsuit, you can deduct your legal expenses "above the line," without AMT or 2% haircut issues.
Cite: Chaplin, T.C. Memo 2007-58.
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AMT: THE INCONVENIENT TRUTH
March 09, 2007
Taxwriters in the new Congress came into office vowing to slay the AMT dragon. They held hearings this week, and the dragon is still alive. One reason: the hearings showed just who it is that the populist Democratic taxwriters have vowed to rescue. It's the top 10% of earners, clustered in high-tax (Democratic-leaning) states.
The Tax Policy Blog has prepared an eye-opening chart:
Source: Tax Policy Blog
That doesn't mean the AMT doesn't affect a powerful political constituency. I would bet that the top 10% of the tax base is by far the biggest source of campaign cash. Still, it presents a marketing problem. The taxwriters have been trying to define "top 10 percent" as "middle class" as part of the debate, but it's not easy. "Save the Volvo Drivers - Repeal AMT" probably won't be a big-selling bumper sticker.
The Tax Policy Blog has the AMT solution about right:
The solution is not to pick our way through quick fixes or bomb one another with class warfare barbs that redefine the "middle class" to suit political ends. The AMT should be addressed. But only full repeal coupled with fundamental tax reform - reducing preferences and treating all income equally - offers a path that will not lead us back here again.
Unfortunately, fundamental tax reform is a policy orphan at the moment.
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CONGESSIONAL HEARINGS ON AMT TO EMIT CARBON DIOXIDE
March 07, 2007
Congress will be holding hearings about the AMT today. It will be lots of noise (AMT - Bad!) and no progress.
If you want to see what the real problems are in fixing AMT, go to the AMT page at the Tax Policy Center site. It won't be as easy as some folks seem to think.
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A MANDATE FOR BOLDNESS
March 05, 2007
Congressional Democrats have been saying they were ready to permanently solve the looming massive increase in the reach of the alternative minimum tax. Republican taxwriters have been kicking the problem down the road a year at a time with temporary increases in the AMT exemption.
Senate budget writers now are looking at a bold solution: ($link):
Senate Budget Committee Chair Kent Conrad, D-N.D., told Tax Analysts March 2 that the chamber's fiscal 2008 budget resolution will include -- at the minimum -- a two-year alternative minimum tax patch.
Whoa! Two years! Audacious!
The AMT is one of those commonly accepted lies has been ignored by both parties for their own reasons of convenience. Republicans have used the projected revenues from the AMT to help make their budgets look balanced; Democrats accept the temporary fixes because the AMT will hit blue-state Volvo drivers the hardest. That's tax policy for you. As former House Ways and Means Chairman Thomas famously put it,
"Don't think in this business that you're dealing with the best and the brightest," he said. "You're dealing with the available and the willing. One of the basic criteria is usually warm and vertical. That's optional in some instances."
The result: an AMT increase that nobody seriously believes will be allowed to take affect, but which is routinely used in federal budgeting and policymaking.
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IRS WEB SITE HAS 2006 AMT ASSISTANT
January 29, 2007
The IRS has posted a handy little web-based program to help do-it-yourselfers determine if they have alternative minimum tax for 2006.
For a quick and dirty idea whether you are likely to have AMT for 2006, you can take my quick-and-dirty quiz:
Do you live in Iowa, New York, California, New Jersey, Massachussets, Connecticut, or another high tax state?
If yes, do you have gross income in excess of $150,000 but less than $500,000 ($700,000 in NY, NJ or CA)? If yes, you probably have AMT.
Do you have a big capital gain in 2006? If yes, you probably have AMT.
Do you have more than 4 kids? You probably have AMT.
Wasn't that easy?
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AMT: IT'S THE DISHONESTY
January 15, 2007
Some of the big-time blogs were discussing the alternative minimum tax over the weekend. The alternative minimum tax is computed with fewer deductions and credits, but with a lower top rate; you compute both "regular" tax and "AMT," and you pay the higher amount. The biggest culprits in triggering AMT are state and local taxes and business tax credits.
Mickey Kaus said that the hassle of computing tax a second time is the real reason people hate it. Ann Althouse replies, "No, Mickey, it's the money." ($4,900 for Ms. Althouse, a law professor in Madison, Wisconsin)
Even the Instapundit weighs in, blaming Turbotax for tax complexity. Of course, regular Tax Update readers know that the root of tax complexity is the HP 12-C financial calculator.
As a confirmed AMT taxpayer, I would tend to agree with Ms. Althouse - it's the money. When I can use the office tax software to do my own return, the complexity doesn't make computation much harder (though it makes tax planning more difficult).
THE AMT BAIT AND SWITCH
But to me, it's really the dishonesty. The AMT has provided cover for sleazy tax policy ever since it was enacted. It works like this: a politician promises a tax benefit. The tax benefit is written so that it doesn't work for AMT.
When the technicians compute the revenue effect of the tax break, they take into account that it won't work for AMT. This makes the tax break much less costly than it would be otherwise.
The politician gets to brag about a brave new loophole, and the taxpayers think he's a great guy, or gal. Then they complain about how that darn AMT got them. It's the ultimate bait-and-switch of tax policy.
This trick has been part of every major tax break in the last 20 years, and many of the minor ones. Perhaps the biggest example is the 2001 Bush tax cuts, which reduced the top regular tax rate from 39.6% to 35%. AMT rates weren't reduced, so many taxpayers had their regular taxes cut, only to pay AMT. Other examples of this are the deduction for state and local sales taxes, the hybrid car tax credit, and the research credit.
Like any bad habit, this one is catching up with Congress; absent new legislation, up to 20% of tax filers will pay AMT for 2007. The politicians are making loud noises about repealing AMT, but they can't afford to. If the Bush tax cuts are to be kept in place, the AMT will provide $1.3 trillion of tax revenue in the next 10 years. So don't believe any politicians who promise to repeal AMT; they'll get it back from you somewhere else. They have to.
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AMT: WHERE YOUR COUNTY STANDS
January 10, 2007
Des Moines' western suburbs are outpacing the rest of the state in economic growth. They also have a less-prized honor: they are also the alternative minimum tax capital of Iowa.
The Tax Foundation has just issued a statistical summary of the AMT that ranks states, counties and congressional districts by how many of their taxpayers were subject to AMT for 2004. The AMT applies a 26 or 28% rate to a taxable income computed with fewer deductions - and no deduction for state and local taxes. There is a large personal exemption, but it phases out. Not surprisingly, high-tax states lead the way in the AMT rankings.
Nationally, New York's Westchester County has the highest incidence of AMT; 12.3% of the tony suburban county's taxpayers had AMT in 2004. Following closely are Hunterdon County in New Jersey and Manhattan.
In Iowa, 3.45% of Dallas Countians filing returns had AMT in 2004, making it first in Iowa and 103rd out of 3,142 counties nationwide. The incidence of AMT was 2.6% in the Peoples Democratic Republic of Johnson and 2.22% in Polk County. The three Iowa counties least hit by AMT were Pocohontas (.13%), Decatur (.16%) and Wayne (.24%).
Thirty-one counties nationwide had no AMT taxpayers in 2004, including two in Kansas and one each in Illinois, Missouri, South Dakota and Nebraska.
When AMT incidence is ranked by state, New Jersey edges out New York for the top rank. Iowa falls all the way to 35th in the percentage of tax returns hit by AMT. If you have taxable income from $150,000 to $500,000 in Iowa, or have lots of kids or capital gains, you are probably helping bring our rank up.
Outside the lower 48, both Aleutians East County in Alaska and Kalawao County in Hawaii had no AMT taxpayers. I suspect one of these counties has more moose, and the other has better weather.
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AMT REPEAL - SO SIMPLE!
January 05, 2007
After many years of hand-wringing, the incoming and outgoing chairmen of the Senate Finance Committee have cut the gordian know and proposed a bill to just repeal the Alternative Minimum Tax. An as-yet unnumbered Senate bill introduced yesterday by Max Baucus and Charles Grassley would simply make the AMT $0 for individuals starting this year.
Nothing to it. Well, nothing except the need to find an additional $750 billion to $1.3 trillion dollars to replace the AMT revenue that the government would lose over the next 10 years.
But it's simple! Just ask Senator Grassley:
I hope the new congressional leaders don't fall into traps on AMT repeal. One is counting on the revenue that the AMT raises for more government spending. It's ridiculous to rely on revenue that was never supposed to be collected in the first place.
That's priceless. Every tax bill passing through Senator Grassley's Finance Committee since 1986 has counted on AMT revenues. It's nice to know that they were just joshing us, that the revenue they projected to justify their tax and spending policies "was never supposed to be collected in the first place." We should remember that next time they issue revenue projections for one of their tax bills.
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LESS TO THE AMT-ISO BONE THAN MEETS THE EYE?
December 11, 2006
Kaye Thomas has an excellent discussion of the new tax break designed to help taxpayers who incurred big alternative minimum tax bills from the exercise of incentive stock options.
The article points out a feature that I had missed: under the bill, the 20% annual refundable minimum tax credit is computed on a declining amount. If you have a $1 million carryforward, your maximum credit is $200,000 the first year, $160,000 the second year (20% of the remaing $800,000), and so on.
My prior article on this break, now updated, is here.
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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 $3.2 million) and so on. Thanks to Kaye A. Thomas, who has an excellent article up about this break.
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GOING OVER THE AMT CLIFF
December 07, 2006
The Wall Street Journal, in a rare editoral page convergence with the Des Moines Register, ripped the alternative minimum tax yesterday. Their editorial ($link) included this chart of how AMT will increase sharply next year under current law:
Arnold Kling at Econlog sees the chart and ponders why so many taxpayers would suddenly face AMT.
The answer lies in the way Congress has been kicking the AMT problem down the road a year or two at a time since 2001. As Dr. Kling notes, the Bush tax cuts lowered the regular tax rates without lowering the AMT rates. As AMT applies when it is higher than regular tax, the arithmetic makes more folks AMT taxpayers.
Congress has fought the arithmetic with "temporary" increases in the AMT exemption. The 2006 exemption is set at $62,550 for joint filers and $42,500 for single taxpayers. Without further legislation, the exemption reverts in 2007 to its "permanent" level of $45,000 for joint filers and $33,750 for single filers. That will be enough to make millions of Americans pay AMT. Hence the jump in the chart above.
Why such obviously foolish tax policy? It's part of Congress' old game of making tax breaks "temporary" to disguise their true cost - the same game involved with the tax breaks in the "extenders" bill that is supposed to come out this week to preserve some other popular tax breaks, including the research credit. With AMT the numbers are so big for each year's temporary break that it is becoming hard for them to pull off.
The silver lining? They might be forced to look at actual tax reform; they might be forced into good policy because they have exhausted the alternatives.
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11 'KEY FACTS' ON AMT
December 05, 2006
The Tax Policy Center has a nice little piece up on "The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections." Fact No. 4:
4. Two main factors behind the explosive growth in AMT: it is not indexed for inflation and the 2001-2006 tax cuts cut regular income tax without a permanent AMT fix. The AMT is not indexed for inflation and, therefore, it affects taxpayers with lower real incomes over time. The 2001-2006 tax cuts more than doubled the projected share of taxpayers who will face the AMT in 2010, from 16.0 percent to 33.6 percent. If the tax cuts had not been enacted and the AMT had been indexed for inflation along with the regular income tax in 1985, the number of AMT taxpayers would have remained between 300,000 and 400,000 through 2010.
This chart shows how the political pressure for an AMT fix might build:
Why is it so hard to fix? Fact No. 9:
9. Repeal would be expensive and regressive. Repealing the AMT in 2007 would reduce revenues by $750 billion through 2016 if the 2001-2006 tax cuts expire as scheduled, and $1.3 trillion if they are extended. Almost 90 percent of the benefits of repeal would go to households with income above $100,000 in 2010.
Where do we look for reform? Raising other taxes or getting rid of the regular tax deduction for state and local taxes. Facts Nos. 10 and 11:
10. Simple reforms could spare most AMT taxpayers. Indexing the AMT for inflation and allowing personal credits against the AMT would reduce the number of AMT taxpayers in 2010 by over 85 percent.
11. Paying for reform is a key issue. Without revenue offsets, the reform above would reduce revenues by $520 billion over the next ten years (if the tax cuts sunset, $940 billion if they are extended). Rolling back the high-income rate cuts and the lower tax rates on dividends and capital gains enacted since 2001 would offset more than half of the revenue loss. If the tax cuts sunset, repealing the deduction for state and local taxes, as proposed by President Bush's tax reform panel, would more than offset the cost of reforming or repealing the AMT.
Of course, when the incidence of taxes is as skewed to the high end of the income scale as it is now, any provision that reduces any sort of tax is going to be "regressive." Good tax policy shouldn't die just because it fails to screw the top 20% of the income distribution a little bit more.
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PROJECTING YOUR 2006 AMT
December 03, 2006
A reader asks:
Your Dec. 1 column advises different tax strategies depending on whether you're subject to the AMT. The only problem is that as of Dec. 1 the IRS has not posted a 2006 AMT form (6251). How can taxpayers decide whether they're subject to the AMT without the 2006 form?
Good question. There should be few changes to the AMT form. The biggest change is the increased exemption amounts legislated last May for 2006, and the change in the breakpoints for the 15% bracket for regular tax. To help those who want to estimate their 2006 AMT, I have dummied up a 2006 form by updating the 2005 form with the new exemption and 15% bracket figures. You can find them in the extended entry below; to see them in full size, click on them.
Remember - these are not official forms, so don't use them to prepare your 2006 returns.
Click here to see the article the correspondent refers to.
UPDATE: Doh! Kerry Kerstetter kindly points out the IRS Draft AMT form is up at the IRS website, here. Instructions are here.
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YET ANOTHER TAXPAYER AMT-INCENTIVE STOCK OPTION DEFEAT
October 12, 2006
The Tax Court shot down yet another theory for avoiding alternative minimum tax on incentive stock options that go bust.
Incentive stock options, or ISOs, are employee stock options with a special tax feature. When you exercise ordinary employee stock options, the excess of their value over the price you pay to exercise the shares is taxed as ordinary wage income at rates up to 35%. In contrast, if you exercise ISOs and hold the stock for one year after exercise, there is no ordinary wage income. Instead, the excess of your sales price over your option price is capital gain, currently taxed at only 15%.
The catch? In computing AMT, the "bargain element" of ISOs is taxed at the time of exercise. That means you have to pay tax up front and hope that the stock is still worth something a year later. It's still a good deal if the stock price goes up, because you get a credit against your regular capital gain tax for the AMT paid when you sell the stock. If the stock tanks, though, it's a bad, bad deal.
Many telecom employees with ISO shares ended up paying large AMT bills on stock that became worthless not long after exercise. Iowa's Ron Speltz, who got clobbered on his McLeod ISOs, is a type specimen. Taxpayers have tried a number of ingenious arguments to avoid the ISO AMT on worthless telecom shares, but to no avail.
ARE AMT CAPITAL LOSSES DIFFERENT?
The Tax Court shot down the latest attempt yesterday. Jonathan Palahnuk exercised ISO in his emplooyer, Metromedia Fiber Network. He paid $99,949 to exercise shares worth $2,185,959. He had no regular taxable income on the exercise, but $2,086,009 in AMT income. As a result he ended up paying $586,066 of AMT in 2000.
Things didn't go so well for Metromedia in the next year, and he sold his shares in 2001 for $248,410. For regular tax purposes, he had a capital gain of $148,461 on the stock that had already cost him $586,066 in taxes. For AMT purposes, he had a $1,937,547 capital loss.
The catch? Capital losses are only deductible up to the amount of your capital gains, plus $3,000. The taxpayer tried to convince the Tax Court that the $3,000 loss limit shouldn't apply in computing AMT. The Tax Court didn't buy it. That means the taxpayer can take $3,000 of AMT capital losses against his AMT ordinary income for the next 646 or so years.
The Moral? I see two. For taxpayers, if you exercise ISOs, and you can't pay the AMT if the stock goes bust, sell enough shares right away to cover your taxes. You'll convert some potential capital gain into ordinary income, but at least you'll stay solvent.
For policymakers, it shows how unintended consequences can turn tax breaks, like ISOs, into tax nightmares.
Cite: Palahnuk, 127 T.C. No. 9.
Related Tax Update Coverage:
ANOTHER BAD DAY FOR AMT-ISO VICTIMS
DES MOINES REGISTER TAKES UP SPELTZ CAUSE
TAX COURT TO ISO-AMT VICTIMS: YOU'RE STILL SCREWED
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TOYOTA, LEXIS FUEL CREDITS PHASING OUT
September 21, 2006
The Toyota and Lexus hybrids are just saving too much energy, so the tax credit for them is beginning to go away.
The IRS announced the phase-out rules yesterday. The phase out chart (courtesy of the TaxProf):
The credit remains fully available for Mercury, Ford and other brands. But remember: the hybrid credit doesn't work for Alternative Minumum Tax, so don't count on pocketing the credit unless you know you aren't an AMT taxpayer.
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ANOTHER BAD DAY FOR AMT-ISO VICTIMS
August 30, 2006
The Tax Court rejected pleas for relief from another taxpayer who was socked with alternative minimum tax from exercising incentive stock options. This taxpayer exercised incentive stock options for PMC-Sierra stock in 2000, paying $183,263 for stock valued at $2,910,251. This was non-taxable for regular tax, but resulted in $2,726,988 of AMT taxable income.
As in so many of these cases, the stock value collapsed and the taxpayer had nothing to show for the ISOs but an AMT bill of $786,000 or so.
The taxpayer tried to compromise her liability with the IRS; when they rejected her offer in compromise, she sued in Tax Court, saying the IRS "abused its discretion" in refusing to compromise the liability. Citing the Speltz case, where the court rejected a similar pleading from an Eastern Iowa McCleod employee, the court turned down the claim.
Cite: Wai, T.C, Memo. 2006-179.
THEY SHOULD HAVE SUED ME!
Tax Analysts reports another AMT-ISO case with some strange arguments. The taxpayer sued for a refund in the U.S. District Court for Central California on the grounds that she should have been sued under four different legal arguments for having exercised her stock options, and that therefore she shouldn't have had any income. The district court said that there was no evidence that any of those arguments would have succeeded, but I hope for her sake that the statute of limitations has expired for all of the things she thinks she should have been sued for.
Cite: Hernandez, DC CD-California, Case No. Case No. CV 04-9365.
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YET ANOTHER AMT-ISO VICTIM LOSES IN TAX COURT
August 29, 2006
The Tax Court shot down another taxpayer attempt to avoid alternative minimum tax from ISO exercise yesterday. Neild Montgomery was an executive for MCG Holdings, a Nevada telephone company. When he left the company his options vested and he exercised shares worth $10 million or so.
Unlike many AMT ISO victims, he sold some of his shares - $2.4 million worth, which went a long way towards covering the AMT due. That was wise, becasue whild ISO exercise doesn't trigger regular tax, the amount that the stock value exceeds the exercise price is considered taxable income in computing AMT. Like so many telecom stocks, MGC (later Mpower) stock collapesed and the company eventually went through Chapter 11. Mr. Montgomery had a $2.4 million tax bill for stock that ended up worthless.
When it came time to pay his AMT. Mr. Montgomery asserted a number of arguments against having to pay AMT. He said the company had made a mistake and disqualified his ISOs. The Tax Court disagreed. He said that he had a "risk of forfeiture" because of securities law rules that kept him from being taxable on his stock. His disposition of $2.4 million of stock hurt this argument. His other arguments were the same one shot down in the recent Merlo and Spitz cases.
The Moral? Again: if you exercise ISOs, figure out whether you can pay the AMT if the company goes under before the one-year capital gain period expires. If you can't, it may be better to sell some shares to make sure you can pay your taxes and forego the capital gain benefits.
Cite: Montgomery, 127 T.C. No. 3.
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YET ANOTHER LOSS FOR AMT-ISO VICTIMS
August 16, 2006
The Tax Court rejected yet another attempt to avoid the AMT consequences of incentive stock options gone bad yesterday.
While most employee stock options are taxable as ordinary income when exercised, incentive stock options are not, at least in computing regular tax; if you hold onto the stock for one year after exercising the option, you get capital gain on the sale, rather than ordinary income. The catch? It's all taxable for alternative minimum tax on exercise.
A Mark Spitz (not the Mark Spitz, as far as I can tell) exercised his ISOs and then saw the share value collapse before a year went by. He then had to pay AMT on the amount the value at exercise of the now-worthless shares exceeded thier exercise price. Like every ISO-AMT victim before him (including Iowan Ron Speltz), he lost.
Cite: Spitz, T.C. Memo 2006-168.
The Moral? If you exercise ISOs, exercise caution, too. If you can't afford to pay the AMT if the shares go bad, sell enough shares to make sure you stay solvent.
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ANOTHER AMT ISO DEFEAT
June 27, 2006
If one door is locked, you try another. That one's locked, too?
That's the problem for taxpayers who exercised incentive stock options and then rode their new shares down to the basement. These taxpayers often owe large amounts of alternative minimum tax as a result of acquiring now-worthless stock.
James Pavlosky exercised ISOs in 2000, paying $96,120 for shares worth $1,612,500. While this generated no income in computing regular tax, the $1,516,380 difference was taxable in computing AMT. He apparently hoped to take advantage of the main ISO break - capital gain tax rates on the disposition of the shares one year after exercise.
Unforturnately, the stock collapsed. Mr. Pavlosky was unable to pay the $430,000 AMT bill and he ended up in bankruptcy.
The Tax Court has been unhelpful to ISO-AMT victims, like Iowan Ronald Speltz, so Mr. Pavlosky knocked at the Bankruptcy Court door for help. Earlier this month the Sourthern District of Texas U.S. Bankruptcy Court declined to open the door that the Tax Court left shut.
It doesn't seem like the courts are going to help the ISO-AMT victims. At this point they can only look to Congress.
The Moral: if you exercise incentive stock options, make sure you have enough resources to pay the AMT if the stock goes bad. If you don't, sell enough ISO stock to cover your taxes. You forfeit the regular tax breaks, but you may avoid a trip to bankruptcy court.
Related Links:
NY TIMES RUNS STORY ABOUT MCLEOD AMT VICTIM
TAX COURT TO ISO-AMT VICTIMS: YOU'RE STILL SCREWED
Pavlosky v. United States (No 05-3350)
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ENERGY CREDITS: NOW SOME EVEN REDUCE AMT
May 31, 2006
One of the cruel jokes in the 2005 "energy bill" was that many of its core tax benefits didn't apply in computing alternative minimum tax. The effect was to negate the tax for millions of taxpayers in high-tax states, like Iowa.
The recently-signed "Tax Increase Prevention and Reconciliation Act" fixes this problem for many of the personal energy credits. Unfortunately, they don't apply to some of the most highly-publicized tax credits.
FIRST, THE GOOD NEWS:
These credits will now count for AMT:
Residential Energy Efficiency Credit. This credit is 10% of improvements to the "building envelope." This means roofing, doors, windows and insulation. It also is available in lump sums for certain appliances:- $50 for each "advanced main air circulating fan";
- $150 for each "qualified" natural gas, propane, or oil furnace or water boiler, and
- $300 for "qualified energy-efficient property," including heat pumps, water heaters, and air conditioners."These credits are limited to $500 in total, including a $200 limit on windows.
Solar credit
The 30% tax credit for residential photovoltaic, solar water heater and fuel cell property also now reduces AMT for 2006.
Be careful: thes credit only reduces AMT for 2006, even though the credits technically apply to property purchased through 2007.
NOW THE BAD NEWS
The alternative vehicle credit, which applies to hybrid cars, still doesn't reduce AMT. That means most Iowans who can afford the Lexus 400h SUV probably won't be able to use the credit.
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IT'S NOT FAIR!
April 27, 2006
The AMT, that is. But it's the law, fair or not. Russ Fox explains.