Ambrosi Donahue Congdon

Fresh from the Last Congress

Relief at Last!

The Tax Relief and Health Care Act of 2006, which was signed into law on December 20, 2006, contains an Alternative Minimum Tax provision which taxpayers and their advocates have been demanding, with no response from Congress, for several years. The new law provides for the potential recovery of substantial Alternative Minimum Taxes previously paid upon the exercise of Incentive Stock Options.

New section 53(e) of the Internal Revenue Code was designed to address what many see as an unfair tax result that has trapped many taxpayers, especially during the technology stock bubble that occurred in the early years of the new century. Under section 53, taxpayers who exercised Incentive Stock Options for pennies when the stocks were trading at a much higher price, were required to report the resulting “spread” as alternative minimum taxable income. At a tax rate of up to twenty-eight percent, taxpayers paid huge amounts of tax in those years with no associated cash income. The anticipation was that the taxes would be recouped in future years, when the stocks were sold for an even higher price. When the stocks instead lost market value, taxpayers were stuck with Alternative Minimum Tax credit carryovers for which little chance existed of recovery. This is because the AMT credit has always been a so-called “non-refundable” credit; it can only be used to reduce a regular tax liability to the level of the alternative minimum tax and no further.

Under the new law, which is effective for six tax years, 2007 through 2012, the AMT credit has been redefined as a “refundable” credit. This means that certain taxpayers will be entitled to refunds of some portions of their AMT credits. The credit will be allowed for “long-term” Alternative Minimum Tax credits, those that were generated at least four years prior, for example, AMT paid in 2003 and before for the 2007 tax year. Although a “lesser of” calculation is included in the statute, most taxpayers will be able to claim an annual credit of twenty percent of their AMT carryover, allowing them to potentially regain 100% of the credit over five years!

The biggest caveat to this helpful legislation is the imposition of a phase-out of the credit at certain income levels. For a married taxpayer filing a joint return for 2007, for example, the credit begins to phase out when Adjusted Gross Income reaches $234,600 and is fully eliminated at an AGI of $357,100. Armed with this information far in advance, taxpayers should time their income accordingly when possible. It should also be noted that although the new legislation is titled “The Incentive Stock Option AMT Provision,” long-term AMT carryovers generated in any way appear to be eligible for refundable credit status.