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By Michael Gray

Retroactive Repeal of AMT for ISO Exercise Proposed

A group of members of the House of Representatives, led by Representative Zoe Lofgren of San Jose, has introduced H.R. 1487, proposed legislation to retroactively repeal the alternative minimum tax treatment of incentive stock options, effective for options exercised on or after January 1, 2000.

The stock market for 2000 and early 2001 has been a disaster creating severe financial hardships, particularly for employees who exercised incentive stock options and have to pay a tax on income they never received.

I urge you to write to your representatives in Congress in support of this legislation.

Writing to your representatives about the details of hardships that have resulted to you and your family because of the alternative minimum tax will be especially helpful. They need to put a "human suffering" face on the issue in order to persuade them to take action.

Since the members of the House of Representatives who introduced the legislation are mostly California Democrats, who are not in favor with the Bush Administration, and this proposal is not part of President Bush's tax relief legislation, it will only pass if there is a very strong supporting "grass roots" lobbying effort. So your participation is essential.

There is also a danger that the interest in this issue will decline now that the filing deadline has passed. We must keep the pressure on in order to persuade Congress and the President to take action.

Jeff Chou, a former Cisco Systems engineer, has launced a web site, www.reformamt.org, to coordinate lobbying to change the tax laws.

While you are writing to Congress, there are at least four more issues to address that are not included in the proposed legislation.

1. Non-qualified stock options. Generally, the employee is taxed on the excess of the fair market value on the date of exercise of stock received over the option price as additional compensation income. If the employee experiences a loss for the subsequent sale of the stock, the loss is a capital loss, which is limited to the amount of capital gains plus $3,000.
   
   I suggest that the loss for the sale of the stock, up to the amount of compensation reported, should be allowed as an ordinary loss and not subject to the capital loss limit.
   
   
2. Employee stock purchase plans. When an employee makes an early disposition, additional compensation income is reported based on the excess of the fair market value on the date the stock is purchased over the option price. The employee adjusts the tax basis (cost to determine gain or loss) of the stock to the fair market value on the date the stock is purchased. If the stock has decreased in value, the result is the employee reports ordinary compensation income and a capital loss for the sale of the stock.
   
   I suggest the same rule should be adopted as the one that applies for incentive stock options. When there is a disqualifying disposition, the ordinary compensation income should be limited to the excess of the sales price of the stock over the option price.
   
   
3. The wash sale rules for incentive stock options. The exception limiting ordinary compensation income for the early disposition of stock acquired by exercising an incentive stock option to the excess of the sale price of the stock over the option price does not apply when a loss would otherwise be disallowed with respect to the transaction. The IRS has stated in proposed regulations that this rule applies when the taxpayer makes a "wash sale" of the ISO stock. This means the income will not be limited if the taxpayer acquires stock within 30 days before or 30 days after the sale, including exercising another ISO or purchasing shares through an employee stock purchase plan.
   
   I suggest the employee should be permitted to make a wash sale to limit the ordinary income from the early disposition of ISO stock.
   
   
4. Restricted stock. The restrictions that result in postponing reporting income for property received relating to employment under Internal Revenue Code Section 83 are fairly limited. For most employee non-qualified option stock transactions, the excess of the fair market value of the stock on the date of exercise over the option price is reported as ordinary compensation income. The same rule currently applies under the alternative minimum tax for incentive stock options.
   
   The income is deferred when the stock is not vested when it is received or when a sale of the stock may give rise to a suit under Section 16(b) of the Securities Exchange Act of 1934, until those restrictions lapse.
   
   There are other restrictions that can apply to stock received by an employee, including "lock out" periods during which employees are not permitted to sell their stock on the public markets, stock held in escrow relating to corporate combinations, and "Rule 144" stock (SEC Reg. Sec. 230.144(d).) These restrictions do not appear to currently qualify for deferral under Section 83.
   
   I suggest these restrictions are significant enough to merit deferral. Otherwise, the employee is being taxed on property that the employee can't sell to pay the tax.

Since all of these items have caused significant economic hardship for taxpayers as a result of the stock market declines of 2000 and 2001, I propose the suggested changes should be adopted retroactively to January 1, 2000.

It appears highly likely that significant tax legislation will be adopted this year. This is an excellent opportunity to correct some of the provisions of our tax laws relating to employee incentives to eliminate unnecessary burdens imposed by the current rules.

Write your representatives in Congress today!

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Consult with a tax advisor

For our readers who aren’t tax advisors, this newsletter is intended to alert you about tax issues that could affect you. It is not a substitute for advice from a professional tax advisor. You will find that getting advice from a qualified advisor is a worthwhile investment. We intend to eventually publish a directory of ESOAA members who are committed to helping clients with employee stock option issues.

Tax advisors should view the newsletter as an alert to become aware of issues relating to employee stock options for further research and study.

(Michael Gray is the co-author of Employee Stock Options – A Strategic Planning Guide for the 21st Century Optionaire. You can order the book at http://www.amazon.com or http://www.barnesandnoble.com/ or buy it at Stacey’s Books.)

P.S.

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