AMT Items

Passive Activities

Saturday, February 6th, 2010 | Print This Post Print This Post | Email This Post Email This Post

One of every seven taxpayers subject to the Alternative Minimum Tax is paying it, at least in part, because of what is known in the tax law as a passive activity. A passive activity is the tax characterization of a certain type of investment, and it may be possible for a taxpayer to reduce his AMT by paying attention to the investments in his portfolio that are triggering this item.

In general, a passive activity is either: 1) a trade or business in which the taxpayer did not materially participate; or 2) an investment involving rental real estate. “Material participation” means active involvement in the operations of the business on a regular, continuous and substantial basis. A typical passive activity is an investment partnership in which the taxpayer is a passive investor, not involved in the day-to-day management.

The passive activity rules were enacted as a way to curtail the use of tax shelters, where individual investors had ownership interests in partnerships that were generating tax losses that the individuals reported in their tax returns. Before the passive activity rules, these investors were allowed to offset other income, like dividends, interest, and salaries and wages, with these losses.

Passive activity losses are very limited in how that may be used against other income for purposes of the Regular Tax. If they cannot be used in the year they are first generated, the losses are carried forward to a future year when they can be used against income generated from the passive activities. In many cases this is the year the taxpayer exits the activity.

For purposes of the Alternative Minimum Tax, these same limitations apply, but the difference is that there also may be AMT items included within the computation of the passive activity loss itself. One common example is depreciation, whether the activity is rental property or a trade or business. For purposes of computing the amount of AMT loss that may be used against AMT passive income, whether in the current year or to be carried forward to be used in a future year, AMT adjustments like depreciation must be taken into account.

As an example of how this works, assume a taxpayer is a partner in a partnership and the Schedule K-1 the taxpayer receives shows the following:

- a Regular Tax passive activity loss of $2,500
- a depreciation adjustment of $500 (less depreciation allowed for the AMT)
- an adjustment of $250 to the gain from sale of property (less gain for the AMT)

In this case the taxpayer’s passive activity loss for Alternative Minimum Tax purposes is $2,250. It is important for the taxpayer to keep records of this difference in order to be able to properly compute his Regular Tax and his AMT in the years the loss is utilized, particularly in view of the impact it could have on his overall AMT planning.

Note – the taxpayer must be careful to have the AMT adjustments going in the right direction. In the example above, one adjustment decreased the loss while the other increased the loss. See the articles on amtblog.com on these two common passive activity AMT items, Depreciation, and Disposition of Business or Rental Property, that appeared on the blog on January 20th and January 24th, respectively.

Posted in K-1 / All other AMT Items | 2 Comments »

Medical and Dental Expenses

Tuesday, February 2nd, 2010 | Print This Post Print This Post | Email This Post Email This Post

The itemized deduction for medical and dental expenses is an item that affects a significant number of individuals who are stuck in the Alternative Minimum Tax. Depending on the type of health insurance an individual has (high deductible plan with a Health Savings Account versus a high amount of coverage with a small copay), and the type of expense incurred (elective procedures versus immediate medical needs), there may be some fairly easy opportunities for AMT savings. The key to this is in the timing of when the medical bills are paid.

For the Regular Tax, an itemized deduction is allowed for medical expenses paid during the year. A tax benefit is received, however, only to the extent the expenses exceed more than 7.5% of the taxpayer’s adjusted gross income (AGI). AGI is the number on the last line (Line 37 for 2009) of page one of the Form 1040.

For purposes of the AMT, however, there is a slight difference – the threshold a taxpayer must exceed is 10% of AGI, instead of 7.5%. This difference in the computation is the AMT item reported on the Form 6251.

The tax-saving strategy for medical expenses is essentially the same for the AMT as it is for the Regular Tax, but it also requires keeping an eye on that 2.5% difference. As mentioned above, the key is when the medical expenses are incurred and, most importantly, when those expenses actually are paid.

If an individual currently is in the AMT, to the extent any elective surgery, dental, vision work, etc. could be delayed until next year (so long as these expenses are not covered by medical insurance, and are not cosmetic improvements that would not be deductible medical expenses in the first place), consideration should be given to doing so. If the taxpayer is not in the AMT next year, a tax benefit might be achieved that would not be obtained this year. Also note that, even if the individual is in the AMT again next year, to the extent a grouping of medical expenses results in exceeding the10% threshold, the taxpayer will at least get a benefit for that amount.

For example, assume AGI is $100,000 and that it will be the same next year. The taxpayer decides to get “fixed-up” a bit, and the list includes a physical exam with diagnostic tests and x-rays, seeing the dentist for braces, and Lasik eye surgery – all together, $20,000 in medical expenses. For a taxpayer in the AMT, it would be a disaster to do half of this now and half next year – the total after-tax cost would be the full $20,000. If instead all the work is done in one year, the IRS offers a nice subsidy – as much as $2,800 for an AMT payer ($20,000 less $10,000 (10% of AGI), multiplied by the 28% AMT bracket).

Even better, if in this example the taxpayer is in the AMT this year but through tax planning will not be in it again next year, the IRS’ subsidy possibly could be $5,000 ($20,000 less the 7.5% of AGI, times the 39.6% bracket – the expected highest Regular Tax bracket in 2011).

Certainly something to think about!

Posted in Medical And Dental | 1 Comment »

Disposition of Business or Rental Property

Sunday, January 24th, 2010 | Print This Post Print This Post | Email This Post Email This Post

In our last article we talked about the Alternative Minimum Tax item resulting from depreciation of business or rental property. A direct corollary of that issue is the AMT item that results from any subsequent sale or other disposition of such property. Critical to minimizing a taxpayer’s AMT is an understanding of the relationship between these two items.

When property is disposed of, a taxpayer calculates the gain or loss based on the difference between the selling price and his tax basis. For something like a stock or a bond, tax basis is the amount originally paid for the investment – that is all that is needed. This same concept also applies to the sale of business or rental property, but with one important difference – depreciation. In the case of depreciable property, tax basis is the amount originally paid, but then reduced for any depreciation taken.

The tax basis of depreciable property changes every year. In the example in the last article, a $10,000 machine was depreciated by taking a $4,000 deduction in the first year, and a $2,400 deduction in the second year. At the end of year 2, therefore, the tax basis of this machine was $3,600 ($10,000 less the $6,400 of total depreciation taken).

What would happen if the machine were sold at this point? The same basic principle of computing the difference between selling price and tax basis applies. Assume, for example, a sales price of $5,000. In this case the taxpayer’s gain would be $1,400, and this amount would be included in taxable income. This is the Regular Tax treatment.

The AMT item arises at the time of sale of property because, in general, a taxpayer uses a different method of depreciation for purposes of the Alternative Minimum Tax than is used for Regular Tax purposes. To the extent the taxpayer has these AMT items from differences in depreciation in prior years, the tax basis of that property similarly is different for the AMT than it is for the Regular Tax. Therefore, gain or loss on a sale of the property also is different. Essentially, the AMT difference in computing the gain or loss is a reversal of the Regular Tax-AMT depreciation differences in the past.

Continuing with the same example, if after two years a taxpayer has been allowed $5,100 in depreciation deductions for the AMT (see the prior article), the machine’s AMT tax basis is $4,900. Assuming a sale for $5,000, taxable gain for AMT purposes would be $100.

This $1,300 difference in taxable gain (the $100 of AMT gain compared to the $1,400 of Regular Tax gain) is an AMT item in the year of sale. This is a favorable adjustment in computing the taxpayer’s Alternative Minimum Tax. It would be entered as a negative number on the Form 6251, making Alternative Minimum Taxable Income $1,300 less than Regular Tax taxable income.

One out of every 14 AMT payers has this item, so it is important that both the Alternative Minimum Tax basis and the Regular Tax basis of depreciable property are properly calculated. Incorrect calculations can have the effect of negating other AMT planning that a taxpayer may have accomplished, costing real tax dollars.

Posted in Depreciation & Disposition of Property | No Comments »

Depreciation

Wednesday, January 20th, 2010 | Print This Post Print This Post | Email This Post Email This Post

Surprisingly, one of every six individuals paying the Alternative Minimum Tax has depreciation as an AMT item. It may or may not individually be a large item to a particular taxpayer, but the good news is that it is easy to plan around, and this planning can be done any time up until the filing of the tax return. In other words, a taxpayer with this item still may have the opportunity to reduce his AMT for 2009.

There are numerous ways depreciation may show up in an individual taxpayer’s Form 1040. One is rental property the individual owns; another is business property if the business is being operated as a sole proprietorship. Other ways are if the business or rental property is in a “pass-through” entity. Examples of these include LLCs, partnerships, and S corporations, in which case the income and expenses, and any of the separate AMT items, are reported on the individual owners’ tax returns.

Here’s how depreciation works. Assume a business asset cost $10,000, and that the period over which it will be used (its “useful life”) is 5 years. Under the basic “straight-line” method of depreciation, the taxpayer would report an expense of $2,000 per year over this period.

But, in an effort to encourage investment, Congress allows a choice of other depreciation methods, all of which allow more of the expense to be deducted in the early years of the property’s life. For example, under something called the “double declining balance” method, here is how the cost would be recovered:

Year 1 – 40%, or $4,000
Year 2 – 24%, or $2,400
Year 3 – 14%, or $1,400
Year 4 – 11%, or $1,100
Year 5 – 11%, or $1,100

Total – $10,000

While the double declining balance method may be used for Regular Tax purposes, it is not allowed for purposes of the Alternative Minimum Tax. The most accelerated depreciation method that may be used for a taxpayer’s AMT calculation in this example, the so-called “150% declining balance” method, would result in depreciation deductions as follows:

Year 1 – 30%, or $3,000
Year 2 – 21%, or $2,100
Year 3 – 17%, or $1,700
Year 4 – 16%, or $1,600
Year 5 – 16%, or $1,600

Total – $10,000

Matching these two schedules, the AMT item in each of the 5 years is the difference between the two:

Year 1 – $1,000 AMT item (AMT income is higher than Regular Tax income)
Year 2 – $300 AMT item “
Year 3 – ($300) AMT item (AMT income is lower than Regular Tax income)
Year 4 – ($500) AMT item “
Year 5 – ($500) AMT item “

Total – $0

The planning opportunity here simply is to choose a depreciation method that does not result in an AMT item. For Regular Tax purposes, a taxpayer may choose to use the 150% declining balance method (the AMT method) or the straight-line method instead of the double declining balance method. By doing this, there will be no AMT item to report. Note that this election is available each year for property that is placed in service during that year. Note also, however, that the choice of method is made at the entity level, so if the property is in an LLC, partnership or S corporation, the election is made in the filing of that entity’s tax return.

Posted in Depreciation & Disposition of Property | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 10

Tuesday, December 29th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Year-End AMT Planning Wrap-Up – Part 2

The AMT items that were talked about in Part 1 of this wrap-up generally were the bigger ones that can, depending on a taxpayer’s situation, present immediate year-end Alternative Minimum Tax savings opportunities. But the other items that were discussed in this 10-week series also are important in making sure the least amount of AMT is paid. Here is a brief recap of these other items, with references to the amtblog.com articles in which each appeared.

Investments: Private Activity Bonds – an individual investing in tax-exempt municipal bonds can receive an unpleasant surprise when he discovers that AMT has to be paid on the interest income from a certain type of municipal bond. See the December 18th article posted on amtblog.com.

Miscellaneous Itemized Deductions – business or investment-related expenses may be deductible under the Regular Tax, but they are not for the AMT. Several planning ideas on how to minimize this impact are presented. See the November 14th article posted on amtblog.com.

Limitation on Itemized Deductions: AMT Adjustment – when a taxpayer is in the AMT, the limitations that apply to itemized deductions are calculated differently from the limitations that apply for the Regular Tax. See the November 25th article posted on amtblog.com.

State Income Tax Refunds: AMT Adjustment – because of the different AMT treatment of state and local tax deductions, any adjustment to these deductions – for example, a refund of overpaid state taxes which generally is treated as income when received – is itself then given different treatment for the AMT. See the November 29th article posted on amtblog.com.

Standard Deduction – a taxpayer is allowed no standard deduction in calculating the AMT. An interesting planning idea here could mean that an AMT taxpayer might be better off not claiming the standard deduction at all. For a discussion of this opportunity see the November 18th article posted on amtblog.com.

Personal Exemptions – similar to the standard deduction, a taxpayer is allowed no deduction for personal exemptions in calculating the AMT. Not a whole lot can be done here, but there always are at least a few planning ideas. See the November 22nd article posted on amtblog.com.

The AMT Exemption, also known as “the annual patch” – the AMT Exemption amount is set annually by Congress. This is a prescribed amount by which a taxpayer’s Alternative Minimum Taxable Income must exceed his Regular Tax taxable income before the AMT itself is triggered. If Congress were to fail to adjust this exemption amount, 24 million new taxpayers would be pulled into the AMT, in addition to the four-plus million already stuck there. See the December 21st article posted on amtblog.com. Also, pay careful attention to the news we will be seeing on this in the near future as we anxiously await Congress’ fix on this again for 2010.

Good luck with your AMT planning. Hopefully each of these articles provided a simplified explanation along with a few 2009 Alternative Minimum Tax savings ideas. Soon we’ll be working on 2010!

Posted in AMT Exemption, AMT Planning in General, Misc Deductions 2-percent Floor, Personal Exemptions, Private Activity Bonds, Standard Deduction | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 10

Sunday, December 27th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Year-End AMT Planning Wrap-Up – Part 1

In our 10-week series of articles on tax planning for the Alternative Minimum Tax, we have looked at many things a taxpayer can do to reduce his AMT liability. With only four days left in which to act in order to reduce 2009’s taxes, here is a summary of these items, with reference to the date each article appeared on amtblog.com. Please refer back to the article for the specific tax-saving steps that still may be taken before year end.

State and local taxes

This item affects 94% of all AMT payers, yet it is one of the easiest to plan for and it can have the most direct impact on a taxpayer’s Alternative Minimum Tax. There are three types of taxes here:

1. Property taxes – by weighing the relative factors of property tax burden, percentage of AMT payers, and size of population, here is a ranking of the top 10 states that are hit the hardest by this item. Residents of these states really do need to focus on this one in particular. See the November 8th article posted on amtblog.com, “Property Taxes.”

#1 – New York
#2 – New Jersey
#3 – California
#4 – Illinois
#5 – Massachusetts
#6 – Connecticut
#7 – Maryland
#8 – Pennsylvania
#9 – Virginia
#10 – Ohio

2. Income taxes – the tax dollars here are larger, on a per-taxpayer basis, than property taxes. While the AMT planning takes a little more work than property taxes, the potential savings still are there. See the amtblog.com article posted on November 2nd, “State Income Taxes.”

3. Sales tax on new cars – this is easy money for those who bought a new car this year, or still are contemplating buying one. See the amtblog.com article posted on November 11th, “Sales Tax on New Cars.”

Stock options, in particular Incentive Stock Options (ISOs)

A large number of corporate employees, generally ranging from the mid-management level up to the “C Suite” folks, have stock options granted to them by their employers. If these options are ISOs, AMT planning is critical because of the major impact the exercise of these options can have on an individual’s Alternative Minimum Tax. Our two-part series of articles appearing on amtblog.com on December 3rd and December 6th, “Incentive Stock Options – Parts 1 and 2,” go through the basic steps in determining whether a taxpayer does in fact have an ISO – often confused with the other types of stock options and equity grants an employer may offer – and then explains how these ISO exercises trigger the AMT. This is a very important read for all those who either have exercised stock options or are contemplating exercising stock options.

Capital gains

The impact of capital gains on a taxpayer’s Alternative Minimum Tax can be a real surprise – and, unfortunately, not a pleasant surprise At first blush capital gains appear to be AMT-neutral, but this is far from the case. The December 13th article on amtblog.com, “Investments – Capital Gains,” explains this issue. To the extent a taxpayer has recognized capital gains in 2009, and/or “harvested” capital losses to offset capital gains, there can be a direct AMT impact. Any capital gain or loss activity between now and December 31 also will have this impact.

Summary

It is not too late to take action on any of the above items for 2009, but time is short. Once the ball drops in Times Square, you’ll be planning for 2010!

Posted in AMT Planning in General, Capital gains & Dividends, Incentive Stock Options Exercised, State Income & Other Taxes | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 8

Sunday, December 20th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Home Mortgage and Investment Interest Deductions

Home mortgage interest and investment interest both are deductible in computing the Regular Tax, although certain limitations apply. The Alternative Minimum Tax similarly allows these deductions, but they are subject to differences in the limitations. Understanding these differences will allow a taxpayer to plan in advance to minimize their AMT impact.

Home Mortgage Interest

In addition to the primary mortgage on a residence, allowable interest includes home equity loans and mortgages on a second home. For home equity loans not used to improve the residence, interest is deductible only to the extent the loan does not exceed $100,000.

Additional restrictions apply, however, before the interest is AMT-deductible. On home equity loans one must look to how the loan proceeds were used. If used to fix up or otherwise improve the primary residence, the interest is fully deductible for the AMT. If instead the money is used to buy a new car (a common way to get cheaper financing than a car loan), or other purpose not involving work on the residence, the interest is not deductible for the AMT. For example, assume $15,000 in interest on the first mortgage, and $2,000 of interest on the equity line of credit that was used to buy a new car. The total interest deduction for the Regular Tax is $17,000, yet for the AMT the deduction is limited to $15,000. That $2,000 is one of the items reported on the Form 6251.

For Regular Tax purposes, a second home that will qualify for the mortgage interest deduction includes certain mobile homes or boats, in addition to the traditional single family home or condominium. For purposes of the Alternative Minimum Tax, however, only interest on real estate loans is deductible – interest on the mobile home or boat loan is not deductible for the AMT.

From a planning point of view, a taxpayer needs to know the AMT consequences of these different types of borrowing. Failure to do so can make a big difference in the actual cost of the loan. If it is deductible, Uncle Sam is paying part of the cost for you; if not, you’re carrying it all on your own.

Investment Interest

Investment interest is interest expense incurred to purchase investments. A margin loan on a brokerage account is an example. This interest expense is deductible to the extent a taxpayer has qualifying investment income. If the expense exceeds the income for any particular year, the excess is carried forward to be used in a future year.

For the Alternative Minimum Tax, investment income is computed the same as it is for Regular Tax purposes, but with a few exceptions.

One exception is private activity bond interest. As discussed in an earlier article, because private activity bond interest is taxed for AMT purposes, it therefore is also included in investment income in computing the allowable AMT investment interest expense deduction.

Other differences follow this same logic, that is, where AMT income is calculated differently from Regular Tax income. One example applies to taxpayers who have rental properties. Here the Regular Tax-AMT difference in computing depreciation directly affects the amount of taxable income from the property, which, in turn, affects the amount of investment income that can offset investment interest expense.

The AMT planning for this is to be aware of the AMT-Regular Tax types of differences that affect income. The more qualifying investment income a taxpayer has, the more investment interest expense he can deduct, keeping the Alternative Minimum Tax burden as low as possible.

Posted in Home Mortgage Interest, Investment Interest Expense | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 8

Friday, December 18th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Investment – Private Activity Bonds

Municipal bonds, or “muni bonds” as they are commonly referred to, offer favorable tax treatment in that the interest earned on them is not subject to tax. This tax-free yield can make them an attractive investment. If an investor is not careful, however, the AMT can apply to make certain muni bonds fully taxable. Unfortunately, many taxpayers discover this only after making the investment.

The general exemption from tax on muni bonds applies only for purposes of the Regular Tax. For purposes of the Alternative Minimum Tax, municipal bonds are divided into two categories – those used solely for public purposes, and those used to support private activities. The latter are called “private activity bonds.”

There are a number of different types of private activity bonds. Here are the descriptions found on the web site of the Municipal Securities Rulemaking Board (MSRB) – the organization that regulates brokers who deal in municipal securities:

Exempt facility bonds – Private activity bonds issued to finance various types of facilities owned or used by private entities, including airports, docks and certain other transportation-related facilities; water, sewer and certain other local utility facilities; solid and hazardous waste disposal facilities; certain residential rental projects, including multi-family housing revenue bonds), and certain other types of facilities. Enterprise zone bonds are also considered exempt facility bonds.

Qualified mortgage bonds – Private activity bonds issued to fund mortgage loans to finance owner-occupied residential property.

Qualified redevelopment bonds – Private activity bonds issued to finance certain acquisition, clearance, rehabilitation and relocation activities for redevelopment purposes by a governmental entity in designated blighted areas.

Qualified small issue bonds – Private activity bonds issued to finance manufacturing facilities in an amount up to $1 million, or higher in certain situations.

Qualified student loan bonds – Private activity bonds issued to finance student loans for attendance at higher education institutions.

Qualified veterans’ mortgage bonds – Private activity bonds issued to fund mortgage loans to finance owner-occupied residential property for veterans.

The main problem with private activity bonds is that the yield the taxpayer earns can be significantly less that what he anticipated at the time he made the investment. For example, assume a taxpayer buys a muni bond paying 4% interest. For a tax-free yield this is a pretty good return. Suppose, however, that this is a private activity bond, and that the taxpayer discovers he is stuck in the AMT. In this case the yield is something less than 3% (4% minus the AMT in the 28% bracket makes the actual yield only 2.88%). Perhaps as an investment this yield isn’t so attractive any more.

The key, as with all planning, simply is to do a little work in advance. The prospectus on any individual bond has to state if it is a private activity bond. For a muni bond mutual fund, the prospectus would be required to tell the investor if investing in private activity bonds is contemplated by the fund.

The AMT is a yield-killer. A little time spent reading or at least inquiring can go a long way towards protecting that precious yield!

Posted in Private Activity Bonds | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 6

Sunday, December 6th, 2009 | Print This Post Print This Post | Email This Post Email This Post

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!

Posted in Incentive Stock Options Exercised | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 6

Thursday, December 3rd, 2009 | Print This Post Print This Post | Email This Post Email This Post

Incentive Stock Options (ISOs) – Part 1

There are many different ways an employer can award an employee with equity, or stock ownership, in the company. Briefly explained below are the ones commonly used for this purpose. Critical to planning for the Alternative Minimum Tax, the employee must first know exactly what form of equity he holds, because only one has direct AMT implications.

Incentive Stock Option – also known by its acronym, “ISO,” or as a “Qualified Stock Option,” this one is an AMT preference item. If the employee holds an ISO, tax planning is critical – significant Alternative Minimum Tax dollars can be involved.

None of the other forms of employer equity ownership listed below has direct AMT implications. General tax planning always is advisable, of course, but these are not AMT concerns.

Non-Qualified Stock Option – the majority of stock options that employees are given are this type. Acronyms used are “N-Q,” “NQ,” or “NSO.” Caution here is appropriate – these commonly are mistaken for the ISO form of stock option.

Restricted Stock or Restricted Stock Unit – this is not a stock option; it is direct ownership, or a direct ownership derivative, of the employer’s stock. Also referred to as “RS” or “RSU.” Restricted Stock itself is sometimes distinguished from an RSU by calling it a Restricted Stock Award, or “RSA.”

Stock Appreciation Right, or “SAR” – this is a bonus agreement between the employer and the employee whereby the employee will be paid an amount equal to any appreciation in the employer’s stock over a set period of time. Also known as “Phantom Stock,” this simply is a cash bonus plan that is based on an increase in the stock’s value.

Employee Stock Purchase Plan, or “ESSP” – these plans allow employees to purchase actual shares of stock from the employer, usually at a discount.

Employee Stock Ownership Plan, or “ESOP” – this is a qualified retirement plan that invests in the employer’s stock. It is similar to a 401(k) plan, but without the investment diversification typically found in a 401(k).

An individual with an equity award received from his employer simply needs to review the above list and make sure he knows exactly what he has. If, and only if, he has an Incentive Stock Option – an ISO – does he need to worry about the AMT impact. But the time to worry is now – Dec. 31 is fast approaching. Come Jan. 1 it is too late to do anything about 2009’s taxes.

Next – understanding why an ISO triggers the Alternative Minimum Tax.

Posted in Incentive Stock Options Exercised | 1 Comment »

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