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By Michael Gray

Impact of Tax Reduction on Stock Option Planning

The Economic Growth and Tax Relief Reconciliation Act of 2001, approved by President Bush on July 7, 2001, will have a modest impact on tax planning for employee stock options.

Noticeably absent from the legislation is any real relief from the alternative minimum tax relating to the tax preference from incentive stock options.

Since the maximum regular tax rate is gradually being scaled back (39.6% for 2000, 39.1% for 2001, 38.6% for 2002 and 2003, 37.6% for 2004 and 2005, and 35% from 2006 until the law lapses at the end of 2010 and the 39.6% rate is restored for 2011), while the maximum long-term capital gains rate remains at 20% and the maximum AMT rate of 28% remain unchanged, more taxpayers will be subject to AMT under the new tax law.

The reduction in the regular tax rate means the tax benefit for holding investments to long-term is decreasing. Is the additional risk of holding the investment adequately compensated by 15% tax savings? For high-risk investments, even the former 20% spread probably wasn't an adequate incentive. You could lose that much in the market in a day.

Also, remember states that impose an income tax usually give no break for long-term capital gains, and the state tax isn't deductible for alternative minimum tax. So, adjust the tax benefit back another 2%. In other words, if the rates aren't changed from the schedule under the new law, plan on a 13% tax benefit for long-term capital gains for 2006 through 2010.

If you are one of the increasing number of taxpayers who are always subject to alternative minimum tax, the tax benefit for long-term capital gains could be only 8%. It's certainly not worth going through emotional distress to qualify for this tax benefit.

It's a worthwhile exercise to make planning computations to understand the risks and potential rewards of your alternative decisions, so your decisions are grounded in reality.

AMT Repeal Introduced In Senate

Senator Joseph Lieberman has introduced SB 1142, which would repeal the tax preference relating to the exercise of incentive stock options.

If enacted, the proposal would be effective for options exercised in calendar years beginning after the year of enactment.

The House proposal for repeal of the ISO AMT preference, HR 1487, would be effective retroactively to options exercised on or after January 1, 2000.

Although the cries for relief are being heard in Washington, I'm not optimistic about the proposed legislation passing. Congress and the White House are having a hard time balancing the budget with the tax reduction legislation already passed this year.

Keep sending your letters, faxes and emails to your representatives in Congress to explain the human suffering caused by our tax laws relating to employee stock options.

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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