AMT Credits With ISOs: New Tax Law Changes Rules (December 2006)
The Tax Relief and Health Care Act of 2006, passed by Congress in the early morning of December 9, makes it quicker and somewhat easier to use up large alternative minimum tax (AMT) credits created by exercising incentive stock options (ISOs) when you hold the stock. See Section 402 on page 61 of this wide-ranging tax bill, which President Bush signed on December 20, 2006.
What The New Rules Mean For AMT Credits
For anyone with large AMT credits, it can normally take years to recover the full credits, and they may never be recovered if the stock price has substantially dropped since exercise. Concerned about employees who held ISO stock and were burned by AMT on paper profits during the boom and bust between the 1990s and 2002, Congress accelerated the tax treatment, starting in 2007, only for unused AMT credits more than three years old (e.g., in 2007 it applies to unused credits from 2003 and earlier). It does not matter whether your stock price has tanked or rocketed since your ISO exercise. Rather, what counts is whether you had a large spread at exercise that triggered AMT and have not used up the credit.
From 2007 through 2012, you will be able to recover each year up to either 20% of these credits or $5,000 (or the full amount if less), whichever is higher.
Example: Previously, you could use up each year only about $3,000 of your remaining $100,000 AMT credit from a prior ISO exercise in 2003. In 2007 you can now use $20,000 (20%) of it and then 20% of the remainder (or either $5,000 or what's left) from each prior year through 2012.
Complicated phaseout rules for higher incomes can cancel the benefits of this tax credit. For 2006 year-end planning, these rules may lead you to accelerate income into 2006 (before this provision become effective) to take advantage of it in 2007.
The new law creates other planning opportunities now, and going forward, when you intend to exercise ISOs and hold the stock for more than three years.
For details on this alternative way to use your AMT credits, see a two-part article entitled AMT Credit Relief: Too Good To Be True, But It Is, by Kaye A. Thomas. Kaye is the author of the popular book Consider Your Options, which we highly recommend.
Editorial staff, myStockOptions.com