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By Michael Gray

Another 2001 AMT Relief Bill To Be Introduced

Republican Jerry Weller of Illinois and Democrats Zoe Lofgren of San Jose, Jim Davis of Florida and Richard Neal of Massachusetts were scheduled to introduce another AMT relief proposal in the House of Representatives on Thursday, August 2.

The proposed legislation would be more targeted than the previous proposals. Taxpayers who had an alternative minimum tax for 2000 from the exercise of an incentive stock option would be able to recompute the additional income for AMT reporting. The income would be limited to the excess of the fair market value of the stock on April 15, 2001 over the option price.

These representatives are seeking examples of middle-class taxpayers who suffered a financial hardship from an AMT relating to exercising an ISO during 2000 to demonstrate to other members of Congress that this isn't an issue isolated to "fat cats."

If you would like to share your story, please call these representatives and your own to let them know how critically important this relief is to you.

Joint Committee On Taxation Proposes AMT Repeal

On July 17, the Joint Committee on Taxation proposed that Congress repeal the Alternative Minimum Tax. The committee said the second tax computation makes our tax laws unnecessarily complex, requiring more taxpayers to get assistance from tax return preparers or to use tax return preparation software.

The problem faced by Congress is that income tax revenues will already be significantly reduced by tax reduction legislation enacted earlier this year. A substantial amount of future income taxes are scheduled to come from the AMT. In order to be "revenue neutral," these revenues will have to be generated from another source.

There is always another alternative. Repeal the regular tax and replace it with the alternative minimum tax.

How Do I Handle My Wash Sale?

If you are going to fight the wash sale rules, I don't have an easy answer to this question, especially if you don't have the money to pay the tax.

Many taxpayers who sold ISO stock were "caught" in the wash sale trap. The problem rule is that a sale of ISO stock during the year of exercise doesn't qualify for the escape hatch (limiting ordinary income to the excess of the sale price over the option price) if the sale wouldn't otherwise qualify to recognize a loss. (Internal Revenue Code Section 422(c)(2), Proposed Treasury Regulation Section 1.422A-1(b)(2).) Under the wash sale rule at Internal Revenue Code Section 1091, no loss is allowed for a sale of stock when substantially identical stock is acquired during the period 30 days before or 30 days after the sale.

Here is the approach I would recommend. (1) File a timely return, following the wash sale rules according to the IRS. If possible, pay the tax. (2) File an amended return, claiming the wash sale rules don't apply. When or if the IRS disallows your claim, you will be in position to file a petition in a Federal District Court or the Court of Federal Claims. If your tax return is audited, you could ask the agent to petition the IRS National Office for guidance as a preliminary step before litigation. By taking this approach, you have the lowest exposure to penalties and interest.

If you are going to litigate this issue, look for an organization to help finance the legal costs. Some suggestions include the American Electronics Association, Silicon Valley Manufacturer's Group, and Pacific Legal Foundation.

It's possible several taxpayers might be able to have a joint suit against the IRS.

I'm not optimistic about the chances of success for taxpayers who did not sell the replacement stock before the end of the year of exercise.

I think those taxpayers who sold their replacement stock before the end of the year of exercise might have a chance of success.

Don't be cheap about this. Get the best professional tax and legal help you can find.

Good luck!

An Observation About Stock Swaps For ISO Exercise

Here is some information about the results of using stock swaps to exercise ISOs.

The AMT adjustment is associated with the shares received in excess of the shares exchanged. The reason is the AMT adjustment is computed "as if" the ISO provisions didn't apply - in other words, as if the option was a non-qualified option. The IRS guidance for non-qualified options in Revenue Ruling 80-244 says that ordinary income is only reported equal to the number of shares received in excess of the number of shares surrendered times the fair market value per share. An equal number of shares received to the number surrendered will receive the tax basis and holding period of the previsously exercised shares.

For regular tax reporting, an equal number of shares received to the number surrendered will receive the tax basis and holding period of the previously held shares. Any additional shares received that were paid for using the previously exercised shares have a tax basis of zero and the holding period starts on the date of exercise. According to Proposed Treasury Regulations Section 1.422A-2(i)(1), the shares with the lowest basis are considered sold first.

For example, Jill Employee exchanges 1,000 shares of Employer (non-ISO and non-ESPP) stock with a fair market value of $10 per share and a cost of $1 per share, acquired on January 1, 20X1 to exercise an ISO for 10,000 shares of Employer stock at an option price of $1 per share (same fair market value per share). The grant date was June 1, 20X1 and the exercise date is January 1, 20X2.

For regular tax reporting, Jill receives 1,000 shares with a tax basis of $1 per share, considered acquired on January 1, 20X1, and 9,000 shares with a tax basis of zero and acquisition date of January 1, 20X2. There is no taxable income for the exercise of the ISO in 20X2.

For AMT reporting, Jill reports an AMT adjustment for 20X2 of 9,000 X $10 = $90,000. She received 1,000 shares with a tax basis of $1 per share, acquired on January 1, 20X1, and 9,000 shares with a tax basis of $10 per share, acquired on January 1, 20X2. Note the amount of the AMT adjustment is the same as if an exchange wasn't made - 10,000 shares X ($10 (fair market value) - $1 (option price)) = $90,000, but the adjustment is all associated with the 9,000 additional shares received.

New Withholding Tables Issued

The IRS has issued new withholding tables for 2001, Publication 15-T. The new tables reflect the reduced income tax rates enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001.

The new federal withholding rate for supplemental income, including the ordinary income from exercising a non-qualified option, has been decreased from 28% to 27.5%

Taxpayers planning on avoiding penalties from underpayment of estimated tax by basing their payments on last year's income tax returns should consider requesting that their employers withhold more tax than the amount from the withholding table. Use Form W- 4, line 6.

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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