Victims of the alternative minimum tax quirk that taxes nonexistent income of incentive stock options when the stock loses value received a welcome holiday gift from Congress.As one of its final actions before adjournment, the 109th Congress passed the Tax Relief and Health Care Act of 2006, one of the provisions of which includes a scaled-down version of legislation originally sponsored by Rep. Sam Johnson, R-Texas, to fix the problem at the intersection of the AMT and stock options. The new law provides relief to many victims by accelerating the refund of stranded ISO overpayment credits that, under previous law, would not be returned within the taxpayer's lifetime.
Under the regular income tax rules, incentive stock options are not taxable at the time that the option is granted or when the option is exercised. However, the spread between the option price and the fair market value of the stock upon the exercise of the ISO is income under the AMT. Taxes paid on these phantom gains were pre-paid taxes and were supposed to earn the taxpayers pre-paid tax credits against future tax liability. However, because the law never worked as intended, the pre-paid credits earned have not been usable. The new law will rebate the pre-paid taxes over a period of roughly five years.
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