Planning for an AMTNOL when ISO exercise price exceeds current market value.

• Author: Moore, Philip E.
• Position: Alternative minimum tax net operating loss; incentive stock options

Due to current market conditions, many taxpayers have significant holding losses for alternative minimum tax (AMT) purposes on stock acquired from exercising an incentive stock option (ISO). Many taxpayers paid substantial AMT after exercising ISOs. The difference between the fair market value of the stock received on the date of exercise and the option price paid is an AMT adjustment (Sec. 56(b)(3)). This adjustment is added to the AMT basis of the stock.

ISOs that are exercised and sold within a year are taxed at ordinary income rates. ISOs that are exercised and held for at least one year are taxed at capital gain rates. Therefore, the taxpayer holds the ISO stock in anticipation it will appreciate and the resulting gain can be converted from ordinary income to capital gain income.

The AMT paid as a result of exercising an ISO generates a minimum tax credit (MTC) that can offset a regular tax liability in future years. The MTC may not be carried back and may not offset AMT liabilities in future years. The MTC credit offsets the regular tax liability when there is no AMT tax liability (i.e., the regular tax is greater than the AMT). Any unused MTC is carried forward.

Because market prices have declined, the taxpayer may have little or no gain for regular tax purposes, but may have a holding loss for AMT purposes. Should the AMT loss be triggered?

When the stock is sold, the difference between the gain for regular tax and the AMT gain is the "adjusted gain or loss." If the adjusted gain or loss generates an AMT net operating loss (NOL), the NOL must be carried back two years (Sec. 172(b)) and AMT paid in prior years may be recoverable (unless an election to forgo the carry-back is filed).

Example:

Year 2000. T exercised ISOs for 80,000 shares at $50 per share with a cost of $0.05 per share in 2000. T has regular taxable income of $212,741 and reports a tax preference item of $3,996,000 ((80,000 shares x $50) - (80,000 shares x $0.05)). The total tax is $1,175,760 and there is an MTC of $1,123,325 to carry forward.

Year 2001. Assume T has a holding loss of $301 per share. Also assume that 80,000 shares of ISOs are sold at $20 per share. T has other taxable income of $225,900. There is a regular tax gain of $1,596,000 ((80,000 shares x $20) -- option cost of $4,000) and an AMT loss of $2,400,000 ((80,000...