Subject:   AMT on ISOs
Date:   Tue, 9 May 2000
From:   Richard

Hi:

I have subscribed to your newsletter and am interested in understanding the payment of capital gains tax on the preference from the sale of ISO’s. Your article entitled “The Amazing Disappearing AMT Credit” lead me to believe that for AMT purposes long-term capital gain is taxed at 28% but for regular tax it is taxed at 20%. Therefore, there is 6% or 8% unused credit to be used against other taxable income.

When reviewing the actual tax return it looks like for AMT purposes the gain is also taxed at 20%. Can you help me understand this?

I appreciate your insight.

Regards:

Richard, J.D., LL.M., CFP
V.P. Personal Financial Services

Answer

Date:   28 Jul 2000

Hello Richard,

I can only give you a brief overview.

For regular tax reporting, there is no tax that results when an ISO is exercised. If the stock meets the holding period requirements, the entire gain when the stock is sold is taxed as a long-term capital gain. (20% maximum tax rate.)

For alternative minimum tax reporting, at exercise the excess of the fair market value of the stock over the option price is a tax preference, added to alternative minimum taxable income as “ordinary income.” (28% maximum tax rate.) When the stock is sold, since a basis adjustment is made for the amount added to income in the year of exercise, the AMT tax basis is the fair market value of the stock at exercise. Assuming the holding period requirements are met, only the excess of the sale price over this amount is taxable for AMT in the year of sale as a long-term capital gain. (20% maximum tax rate.)

Since the 20% maximum tax rate applies to any capital gain exceeding the original preference for both regular tax and the AMT, some additional AMT could result from the disallowance of some deductions for AMT, such as state income taxes. The AMT attributable to these disallowed deductions can erode the AMT carryover.

Here’s a “rough and dirty” example.

Year 1 – exercise incentive stock option.
Tax preference	$100,000
AMT rate	28%
AMT	$ 28,000
Year 2 – sell related stock (assume long-term capital gain.)
Regular tax
Taxable gain	$100,000
CG rate	20%
Regular tax	$ 20,000
AMT
Due to basis adjustment,
no capital gain	$0
CG rate	20%
AMT	$0
a)Excess of regular tax over AMT	$20,000
b)AMT credit c/o	$28,000
AMT credit allowed lesser of a or b	$20,000
Regular tax	$20,000
Less allowed AMT credit	20,000
Net tax	$0
AMT credit c/o to year 2	$28,000
AMT credit used year 2	20,000
AMT credit c/o to year 3	$8,000

I haven’t included any details for erosion of the carryover for deductions disallowed for AMT.

I hope this helps!

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options – Executive Tax and Financial Planning Strategies.