Stock options and AMT: tax court says "no hardship".

• Author: Barton, Peter C.
• Position: Alternate minimum tax

The Tax Court ruled, in Spelt& 124 TC No. 9 (2005), that an IRS Appeals Officer did not abuse discretion in rejecting a Sec. 7122 offer-in-compromise (OIC) when the taxpayers incurred a large alternate minimum tax (AMT) liability on the exercise of incentive stock options (ISOs). The AMT liability greatly exceeded the taxpayers' selling price for the stock, thereby creating a serious economic burden and lifestyle changes for them and their family. The court also interpreted 1998 changes to Sec. 7122.

Background

Sec. 7122 authorizes compromise of any civil or criminal case arising under the internal revenue laws. In 1998, Sec. 7122(c) and (d) were amended for OICs and installment agreements. Sec. 7122(c)(2)(A) specifics that an OIC should allow a taxpayer to have adequate means to pay basic living expenses. Regs. Sec. 301.7122-1 provides three grounds for compromise: doubt as to liability, doubt as to collectibility and promotion of effective tax administration. Under the third ground, compromises are allowed to prevent economic hardship. Factors supporting a finding of economic hardship include a taxpayer's inability to earn a living due to illness, and the need to support dependents with the income and/or assets he or she has. Examples are provided; see Regs. Sec. 301.7122-1(c) (3)(i) and (ii).

Regs. Sec. 30l.7122-1(c)(3)(iv) allows compromise when, "due to exceptional circumstances, collection would undermine public confidence that tax laws are being administered fairly" An example would be a taxpayer who learns at audit that he was given erroneous tax advice and is facing additional tax, interest and penalties. Section 5.8.11.2.2 of the Internal Revenue Manual (IRM) points out that such compromises will be rare, because it would undermine Congress's will if the IRS found that particular tax statutes were unfair. Also, there would be unequal treatment--some taxpayers would fully pay their tax liability while others would have theirs compromised due to perceived unfairness in the law.

Secs. 421 (a) and 422 defer regular Federal income tax on the exercise of ISOs. However, AMT is imposed on the exercise of such options under Sec. 56(b)(3).

Facts

Ronald Speltz earned $75,000 at McLeodUSA (McLeod) in 2000, which increased to $90,000 by 2004. In 2000 he exercised McLeod ISOs, resulting in $206,191 of AMT, even though joint adjusted gross income was $142,070 and regular tax on his joint return was only $18,678. The return showed a liability...