The AMT Credit Fairness Act has been introduced in the House with significant bipartisan sponsorship. The bill provides relief for incentive stock option alternative minimum tax victims by accelerating the refund of stranded ISO AMT overpayment credits that, under current law, would not be returned within the taxpayer's lifetime.
The legislation was introduced by senior House Ways and Means member Rep. Sam Johnson, R-Tex.
"Many taxpayers across the nation have floated the government an interest-free loan for years because of the interaction of tax rules on the alternative minimum tax and incentive stock options," said Johnson. "The AMT was never meant to be a system that forced families to prepay taxes with little expectation of ever being able to use their accumulated credits. With the relief from this bill, families who have put second mortgages on their homes, cashed out retirement savings, sold assets and struggled to work out payment plans with the Internal Revenue Service can get their money back and get on with their lives."
The legislation lays an important foundation for resolving the ISO AMT crisis, and addresses a severe inequity within the AMT tax system, according to Tim Carlson, president of the Coalition for Tax Fairness.
"Congressman Johnson has taken a critically important step in addressing the unintended and unjust effects on hardworking Americans caused by the current ISO AMT tax provisions," he said.
Johnson's bill would fix a portion of the AMT problem for those who purchased incentive stock options from their employer, and would allow taxpayers with AMT credits that are more than four years old to begin to rebate them either at 20 percent per year, or at $5,000 per year, whichever one is greater. These AMT credits currently amount to an interest-free loan to the government.
"No one should have to float the government an interest-free loan forever," observed Rep. Johnson.
Trouble from the bubble
Many families experienced this financial disaster as a result of technology companies offering ISOs, according to Johnson. For a great majority of the employees, things went south fast when the so-called "tech bubble" burst, and families were faced with paying the AMT on phantom gains.
In most cases, upon purchasing ISOs, people were automatically thrown into the AMT. Although critics have argued the wisdom of companies granting ISOs, with all their complications, to middle managers and rank-and-file employees who did not routinely use tax professionals and financial planners to manage their affairs, the problem persisted.
In a recent case that underscores the way the AMT hurts ISO holders when the stock loses value after the option is exercised, a taxpayer, Ronal Speltz, earned about $70,000 a year, and his employer issued him ISOs to augment his salary. Instead, the ISOs triggered a tax nightmare when he exercised them before the tech bubble burst, leaving him with nearly worthless stock but with an unexpected tax bill of nearly $225,000.
The Coalition for Tax Fairness' Carlson, arguing pro bono in the tax court on behalf of Speltz, lost the case because the court found that the taxpayer failed to qualify under the "effective tax administration" provisions of the Offer-in-Compromise Program. Since the taxpayer had sufficient income to meet "basic living expenses," he didn't qualify for the condition covered by the regs - "where collection in full could be achieved but would cause economic hardship."
In a report to Congress, National Taxpayer Advocate Nina Olson said that she believes the effective tax provisions in the code would cover unfair application of the AMT.
"The IRS summarily rejects ETA offers in cases where one of the inequities faced by the taxpayer is an 'unfair' operation of the AMT," she stated. "The IRS reasons that a compromise of AMT liabilities would be a way to circumvent the will of Congress. However, this position overlooks the possibility that the 'unfair' operation of the tax rules may be one of many factors that may justify the acceptance of an ETA offer based upon the unique circumstances of a particular taxpayer."
"This is typical of the many cases where the taxpayer thinks he's getting something of value, but ends up being hurt by the ISO," said Carlson. "The alternative minimum tax often results in taxes exceeding 400 percent of these employees' annual salaries, with the double whammy that they never see any actual income from the worthless stock."
This is the reason that the push for legislative action on this specific harm is going ahead, despite the eventual prospects for total repeal of the AMT, according to Carlson.
A matter of urgency
"Some people questioned why we would deal with this problem now, rather than wait for the AMT to be repealed," he said. "But there is a tremendous urgency where people are losing their homes, their retirement accounts, and are pulling their kids out of college because these huge prepayments are sucking everything they have and everything they don't have, and not allowing them to live a normal life."
"The AMT credit was initially intended to be a prepayment on future income," he explained, "but it was not crafted in a way in which it could appropriately account for a dramatic decline in the market. These people will never have the future income, but the prepayment is still due - a stranded AMT credit, with no way for them to recover it in their lifetime."
Carlson is optimistic that the bill proposed in the House Ways and Means Committee will be passed. "The prospects are quite good. We worked hard to build a base of support in the House, and we're working to prepare a parallel base in the Senate," he said. "The reception in the Senate has been similar to that in the House. Once people understand the injustice and the gravity of the problem, they realize that this is a problem that needs to be fixed now. We're encouraged that we'll get similar legislation in the Senate shortly."
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