Does an exchange of company shares when exercising an ISO change the AMT result?
October 5, 1998
Q. Are the rules different with respect to the AMT if you pay for your shares with company stock instead of cash. I.e., in your example: “The option prices was $1.75 per share (and so you wrote the company a check for $5.250). The market price was $31.75 per share. You have no additional taxable income for regular tax purposes. You DO however have $90,000 of additional taxable income for alternative minimum tax purposes.”
If I exchanged 165 shares of company stock ($5,250 / $31.75 = 165) for the optioned shares, do I still have to pay the AMT? If so, it seems that the ISOs are taxed twice – once at the AMT level and then again when you sell them, since it appears that the basis remains the option price uncorrected for the AMT tax paid.
Are there any ways of minimizing the tax on ISOs?
How would you recommend getting tax advice on ISOs?
The rules are the same with respect to the AMT whether you pay cash for your shares when exercising the options or exchange shares. If you don’t have the cash, you receive a tax benefit by exchanging shares because the potential gain for the shares surrendered isn’t currently taxable.
Although it seems the ISOs are taxed twice, there are offsets that are allowed. First, the excess of the tentative alternative minimum tax over the regular tax in the year of exercise that is attributable to timing differences, including the AMT preference, is carried over as a tax credit to be applied in future years. The tax credit is allowed for the amount the regular tax exceeds the tentative alternative minimum tax in future years. Second, a basis adjustment is allowed when computing the tentative alternative minimum tax in the year of sale for the preference determined in the year of exercise. The basis adjustment reduces the tentative alternative minimum tax, which should help the taxpayer use the alternative minimum tax credit in the year the stock is sold.
This is not a perfect system, because the maximum tax rate for determining the alternative minimum tax in the year of exercise is 28%, but the maximum tax rate for long-term capital gains in the year of sale is 20%. The unused credit may be used to reduce the tax on other type of income, usually ordinary income, such as wages, that may be subject to regular tax rates up to 39.6% compared to 28% for alternative minimum tax.
For additional details, see our complimentary report, Executive Tax Planning For Incentive Stock Options. In the question and answer on this site comparing incentive stock options and non-qualified options, we give an example showing the AMT basis adjustment and minimum tax credit carryover.
There are ways to minimize the tax on ISOs. However, we think it’s more important to say that you can develop strategies for effectively managing your ISOs. Additional matters to consider in the strategies include planning the cash flow to pay the taxes, including estimated tax payments, and managing investment risk.
You should seek competent professional help. We suggest you find a CPA who regularly deals with these issues. Referring to our articles and reports can give you information to help screen prospective tax advisors. Consider getting references from prospective CPAs you might retain. Get referrals from other executives you know who are also dealing with these issues.