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!

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!

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.