How will my Incentive Stock Options be taxed?

August 18, 2000

Subject:   amt and net tax question
Date:   Sun, 23 Jul 2000
From:   Ed

Mike, used your web site for info, thanks. One question I have been wrestling with which I keep coming to the same conclusion. Let me know if you know different.

ISO taxed at AMT rate (26-28%) when exercised. Stock sale later taxed at long (20%) or short (depends upon income tax rate) term tax rates. That nets to a effective tax of 26-28% plus minimum 20% = 46-48% net tax on that portion of the sale ( gain at exercise price time) and regular long/short term rules for everything above that. It could be worse 28% + short term sale rate.

A net 48% tax rate on ISO’s gain (at exercise time price)! What incentive is that? This seems like the most tax heavy burden on any personal income in our tax laws. I could see if the AMT was paid once on that portion/gain, but not have that portion taxed again when stock is sold, or just taxed to recover any increase if short term sale and higher income bracket applies. For instance tax bracket at time of sale 35%, paid AMT at 28%, owe the difference 7% on that asset gain…now that may be fair.

AMT just seems like a way to double tax, above the max personal income rates and short or long term asset sales rates for individuals? How can we stand for this. I thought I heard a news clip earlier in the year on a proposal in congress to eliminate the AMT for ISO’s…but never heard anything more.

Do you know of any efforts ongoing where I can help provide some backing to get this tax law changed. Seems like there isn’t enough lobby power organized behind this bad law.

Your thoughts are appreciated.


Date:  28 Jul 2000

Hello Ed,

I’m afraid you’re confused about how the AMT and regular tax systems interface with each other.

For “timing differences” like the spread at exercise of an incentive stock option, the alternative minimum tax is like a prepayment of tax.

The AMT attributable to timing differences is carried over as a tax credit that can be applied to reduce the regular tax in a later tax year.

This is not a perfect system, so in some cases it can be hard to recover the entire AMT.

I suggest that you study Form 8801 and the related instructions.

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
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

In some cases the carryover to year 3 can be reduced because of deductions that are disallowed for the AMT, such as state income taxes.

No legislation is likely to be approved this year for repeal of the AMT adjustment for ISOs.

Write to your representatives in Congress (after the election) if you would like to see changes in this tax law.

I hope this helps!

Mike Gray

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

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