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AMT Credit Relief for ISO Holders
Congress passed the Tax Relief and Health Care Act of 2006 on December 8, 2006. This contains important changes that allow certain taxpayers to use up large Alternative Minimum Tax (AMT) credits.
These credits were created by exercising incentive stock options (ISOs) and then holding the stock after exercise.
This new rule takes effect on January 1, 2007. Effectively, Congress has accelerated the tax treatment for unused AMT credits more than three years old, e.g., in 2007 it applies to unused credits from 2003 and earlier. The rule is effective through 2012.
For anyone with large AMT credit carryforwards, it can take years to recover the credits, and in some cases the credit may never be fully recovered if the stock price declined after the exercise.
To take advantage of the new rule, the credit must have been generated by AMT that results from income from "timing items" such as ISO exercises, and not from disallowed deductions such as state tax payments.
There is an annual limit on the AMT credit you can claim in any one year. The general rule is that you can recover 20% of the old AMT credit each year. For example, if you have $100,000 of the old AMT credit in 2007, you can recover $20,000.
However, if the old AMT credit is less than $25,000 you can claim $5,000 or the full amount of the credit, whichever is less, each year.
As with most tax benefits, there is a phaseout rule based on income levels. For joint filers, the credit is phased out for gross income between $234,600 and $357,100. For single filers, the phaseout applies to income from $156,400 to $278,900.
Congress enacted this law to give relief to employees who held ISO stock and were adversely affected by AMT on paper profits during the stock market's roller coaster ride in the 1990s through 2002.
We will be focusing on every client's AMT credit to take the maximum benefit possible. This provision may be one of the few in which there is an advantage to married taxpayers to file separately.
President Bush is expected to sign the new law shortly.
One interesting note, tax forms mailed by the IRS may contain forms that do not reflect some of the provisions of this tax act.
More information about the AMT credit and other changes contained in this bill is available at Fairmark and The House Committee on Ways and Means.
