Amt Planning Ideas...incentive Stock Options (isos) - Part 2

An individual holding an Incentive Stock Option to acquire his employer's stock

, and considering taking advantage of this fall's run-up in the price of that stock, needs to be planning for the potential Alternative Minimum Tax impact. Time is important - Dec. 31 is fast approaching, and after that it is too late to do any AMT planning for a 2009 ISO exercise.

Why does an ISO exercise trigger the Alternative Minimum Tax? Let's first summarize and compare the Regular Tax and the Alternative Minimum Tax impact:

- Regular Tax - When an ISO is exercised, the taxpayer does not have any taxable income at that point. Later, when the stock is sold, there will be capital gain income, taxed at the favorable capital gain rates. Note that this is the big tax advantage to ISOs over nonqualified options, which are taxed at ordinary tax rates on the date of exercise.

- AMT - When an ISO is exercised, an AMT item is generated and must be reported on the Form 6251. The amount of this item is the income the taxpayer otherwise would have paid Regular Tax on if the stock option were not an ISO. Depending on the size of the exercise in relation to the taxpayer's other income, this ISO exercise AMT item can be the single thing that pushes the taxpayer into having to pay the AMT.

Here is how an individual planning to exercise an ISO computes the amount of the AMT item:

The "spread," or difference, between what the taxpayer pays for the stock (the "exercise price") and the value of the stock on the date of exercise (the "fair market value" or "FMV") is the dollar amount of the AMT item. As an example, assume the following:

$20 - the exercise price, or the amount the employee must pay his employer to acquire each share of stock.

$50 - the FMV of each share on the date of exercise. For a publicly-traded company, this is the average of the high and the low trading prices on that day.

5,000 - the number of shares the employee can acquire through the exercise of the option.

The "spread" per share is $30 and the number of shares is 5,000, so the total dollar amount of the spread is $150,000. This is the amount of the AMT item to report on the Form 6251. As mentioned above, if this were not an ISO, but a regular "nonqualified" option, this amount would be income, taxed immediately at up to 35% plus any related payroll taxes, and reported in the employee's W-2. But because in our example we are assuming that we do have an ISO, the $150,000 is not subject to tax at this point. Caution, however: as an AMT item, without advance tax planning this amount easily could be enough to trigger the AMT for any particular taxpayer.

Assuming the taxpayer does his tax planning and avoids triggering the AMT, the tax savings in this example is as much as $30,000 or even more - not an insignificant sum for a taxpayer to keep in his pocket rather than turn it over to Uncle Sam. The $30,000 is the difference between the top Regular Tax bracket of 35% and the current capital gains rate of 15%, multiplied by the amount of income.

There are a number of technical rules that must be met for a stock option to qualify as an ISO. The employee must consult with his company's HR and/or Law Departments to confirm that these rules have been met.

Remember - December 31 is only 3-1/2 weeks away!

by: George Bauernfeind

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