Declare the Pennies on Your Eyes

Jay Hancock visits some victims of the Alternative Minimum Tax:

Remember all the paper profits you lost when the Nasdaq crashed? Don't feel too bad. The Millers not only lost their dot-com quicksilver; thanks to the AMT they owe tax on it, too….

The IRS doesn't just want the $117,000 the Millers are supposed to owe on income that never existed. It wants more than $200,000, including interest and penalties, and it has rejected every settlement offer they have made….

The Millers are especially exasperated because the IRS owes them almost as a much money as they owe the agency. The credits they're due for AMT tax liabilities on VeriSign stock that later collapsed are $115,000; the principal balance of their delinquent tax is $117,000. Why not just call it a wash?

No, the IRS said. Pay the tax and penalties now, it said, and take the credits year by year, in thimblefuls, over the next three decades.

Comments

[FinFangFoom]

I guess this is get me aggravated by retarded laws Monday.

[brotherben]

The laws are only as retarded as those that wrote them. And they (congress) are only as retarded as the voters allow them to be.

[Warren]

This is exactly the sort of thing that leads me to conclude the IRS is a threat to the Republic.

[FairTax]

This kind of abuse will continue to go on until we scrap the entire tax system and put in something like the FairTax program.

[Anita Dickens-Hyde]

Are fairs not taxed already? Or do the County Fair and State Fair associations have a good lobby?

[P Brooks]

Can we put the IRS in the new WTC building? Just in case?

[Warren]

I was a booster of the FairTax for a while. But after mulling it over, I decided it was no better than what we got now. There's nothing about FairTax that would prevent congress from complicating the tax code every bit as much as it is now. The prebate provision is a VERY BAD IDEA right from the get-go, and makes the whole thing a non-starter. Enforcement would be near impossible and the incentive and ease of cheating would be a force of corruption to rival the War On Drugs.

I like a currency tax. The government simply prints the money it wants to spend and we all pay the tax through inflation. The only drawback is that every time this has been tried in the past, it has led directly to the collapse of the economy. But I think that could be avoided with a little tinkering. Like adopting a gold standard and constitutionally limiting the rate of growth.

[Jim Lippard]

The Millers had incentive stock options in VeriSign that they exercised and held, instead of exercising and selling. They recognized a huge gain at the time of exercise--they got hundreds of thousands of dollars worth of stock for pennies on the dollar. The fact that they failed to sell and ended up losing that gain doesn't change the fact that they had a large material gain at the time of exercise that they owe taxes on. Rita Miller calls this a "phantom gain," but there was nothing phantom about the gain at the time the ISOs were exercised. Now, if this was an early exercise of unvested stock, they would only incur AMT as the stock vests, unless they proactively filed an 83(b) form to cause the liability to be incurred all at once.

Their ISO paperwork should have told them to consult with a tax advisor. It doesn't appear that they did so--they should have cashed out a portion of their ISOs at the time of exercise in order to cover their tax liability, in which case they wouldn't have been stuck in this position.

[Warren]

Jim Lippard,

So capital gains should be assessed at whatever the highest possible gain that could have been realized in the past year!? I'm scanning your post for sarcasm but maybe my detector isn't sensitive enough. Otherwise that is the dumbest post I've read all year.

If they didn't sell the stock when it was worth "hundreds of thousands of dollars", then they simply didn't realize a "large material gain". You can call them foolish if you want, but to assess tax on what they could have sold it for, but didn't", would be like assessing income tax on gross profits.

[Ayatollah Usoe]

Just commenting on the post above from Anita Dickens-Hyde. Do you know Ima Payne-Diaz?

The alt min tax is that 26% flat tax we've all been waiting for, only we were hoping for a different implementation. I'm in alt min, with no mortgage and no dependents, just a high state income and property tax burden.

[Dr. Kenneth Noisewater]

Jim Lippard is correct that the Millers are the victims of their own poor planning. They really should have consulted a tax expert before exercising their ISOs so they would know the consequences. However, selling at the time of exercise has its own downside. It means that whatever gain is realized at the time of sale would be taxed as ordinary income, not capital gains. And another thing to consider (which affected me) is the exercise of restricted shares. I couldn't sell a block of shares that I exercised shortly after my company's IPO because we couldn't sell shares until 6 months after the IPO.

The AMT definitely sucks bad and should be reformed. It often leaves people with some pretty crappy choices to make.

[Jim Lippard]

"So capital gains should be assessed at whatever the highest possible gain that could have been realized in the past year!? I'm scanning your post for sarcasm but maybe my detector isn't sensitive enough. Otherwise that is the dumbest post I've read all year."

Your first sentence has no relation to anything I said. The AMT liability was incurred *at the time of exercise* or *at the time of vesting* (depending on whether the options were already vested and whether they filed an 83(b)). There was no tax liability imposed at "whatever [time] the highest possible gain the could have been realized in the past year."

I concur with Dr. Noisewater that the AMT sucks and should be reformed, and he correctly points out some additional relevant facts that I omitted (cashing out at time of exercise means the gain over the exercise price is taxed as ordinary income instead of as capital gains).

I also got heavily hit by AMT in 2000 as a result of ISOs; I sold stock to pay my AMT liability at the time, and have only now (with my 2006 return) finished applying the AMT credits I obtained when I sold that stock with a considerable AMT loss. Like the Millers, my stock was in a dot-com high-flyer that crashed and burned (except that my stock went to zero after a bankruptcy).

These days, companies are far more likely to give restricted stock units (RSUs) instead of incentive stock options; the tax implications are at least much simpler (just ordinary income, incurred at the time of lapse/vesting).

[MP]

These days, companies are far more likely to give restricted stock units (RSUs) instead of incentive stock options; the tax implications are at least much simpler (just ordinary income, incurred at the time of lapse/vesting).

That's what I dealt with. I paid the taxes up front and never had an AMT issue. I only got burned by holding on to the damn things below my strike price. stupid greedy stupid

I'm with Jim and Dr. Ken. The Millers are victims of their own poor planning (admittedly due to poor information and a convoluted tax code). But still, considering the money that was on the line, they should've been more diligent.

[grylliade]

The Millers are victims of their own poor planning (admittedly due to poor information and a convoluted tax code).

Well, if you RTFA, you discover that they hired a financial adviser and a tax lawyer. Unfortunately, neither of them had a clue that this is what was going to happen. So maybe the Millers chose badly in terms of their advisers. Should they get hit this badly for that crime?

The state of tax law in the US today is such that the average citizen can't even realize if their tax advisers have any clue what the law is, even if said advisers is a lawyer. Now these people (and others) are being asked to sell their homes and retirement savings, to pay taxes on phantom gains. And your advice to them is, "Tough shit, pay the taxes"?!? Especially when the IRS has rejected all settlements that the Millers have offered.

This isn't anything that the Millers have done wrong. When someone is screwed because of bad law, it's not their fault. It's the fault of the people who made the law, and those who enforce it blindly. Maybe they could have avoided this situation through better foresight. The law is still wrong, and the Millers still shouldn't be held responsible for bad law.

[Dr. Kenneth Noisewater]

Grylliade:

A tax attorney that doesn't know about the AMT liability of exercised ISOs strikes me as being almost criminally incompetent. While the specific details of the rules around AMT are quite a bit convoluted, it was easy enough for a layperson such as myself to understand that exercising my ISOs could have significant tax implications for me and that I should carefully plan any exercise of the shares I had vested. If I were the Millers, I'd be looking to sue my "tax attorney".

[Rex Rhino]

All you evil right wing capitalist bastards!!! Everyone knows that it is totally fair that middle class people who hire accountants and tax lawyers and make every effort to comply with the law should be bankrupted and imprisoned when the laws are too complicated for even government certified experts to understand!

Remember folks, ignorance of the law is no excuse... So please brush up on hundreds of thousands of pages of federal rules, and millions of pages of case law, and be able to exercise flawless legal judgement on one of billions of permiatations of each, and then you have nothing to worry about! If you don't have a legal team of at least 50, then you shouldn't be investing in the first place!

[T]

Some of you must be in the wrong place. The government is claiming these people owe money on imaginary income, and y'all claim it's their fault? Let's be clear: if they didn't sell the stock, they didn't make any money, no matter what the IRS claims.

It's just as screwed up now as it was when it first hit the news during the dot.com crash, and there is no excuse for the way the tax code is written on this subject. None. Read the article again: the government is taxing them on income they never made.

Why the hell is anyone here defending the government on this? Just because you got screwed on it, somebody else should too? What kind of crap is that?

[MP]

Some of you must be in the wrong place. The government is claiming these people owe money on imaginary income, and y'all claim it's their fault? Let's be clear: if they didn't sell the stock, they didn't make any money, no matter what the IRS claims.

So if your employer gives you a Bentley, it's imaginary income until you sell it?

[Geoff Nathan]

So if your employer gives you a Bentley, it's imaginary income until you sell it?
No, because a stock option is just a meaningless piece of paper until you sell it, but a Bentley is a car, the moment you hold the keys in your hand.

[kevrob]

I suppose if you used the stock in question as collateral to borrow money on, that might justly "start the clock" on tax liability before a sale, if one considers any part of an income tax just.

This pilpul is a prime example of how complexity in rule-making makes the law unreliable as a guide to behavior by normal humans. This couple relied on "expert" advice, and got reamed. Is anyone alleging that they didn't act in good faith?

Kevin

[MP]

No, because a stock option is just a meaningless piece of paper until you sell it, but a Bentley is a car, the moment you hold the keys in your hand.

These are exercised options we are talking about here. The Millers had stock in hand. They simply chose not to sell it. There is nothing meaningless about it.

[T]

MP,

Do you not understand how stock options work? The company doesn't "give" you a damn thing but the option to buy shares at a set price. Once you exercise that option, you spent your money to buy shares of stock. You have made no money at this point in time. If you sell the shares again later for more money, you have realized a capital gain.

RTFA. The couple exercised the options and sat on the shares. The IRS is taxing them for some imaginary value the shares would have had if they had sold them at some arbitrary point in time.

So to use your analogy, if your employer offers to sell you a Bentley, and you buy it, you haven't made any money, now have you?

[george]

If my employer gives me a hundred-thousand-dollar car, I say hooray. If when I come to sell it, it turns out to be pretty sheet metal wrapped around a moped engine, I say it's not really a h-t-d car, and I shouldn't be taxed as though it were.

That may not be the law, but "the law is a ass".

[juris imprudent]

T,

I'll give you a different example with pretty much the same [tax] effect - debt forgiveness. Due to some bizarre circumstances I had a mortgage paid off by the county. You would say I didn't realize the gain until I sold my property - but that isn't the way the tax authorities (both federal and state) saw it. I owed the debt relief as regular income that year. I ended up getting a new mortgage so I could pay the taxes.

[crimethink]

No, because a stock option is just a meaningless piece of paper until you sell it, but a Bentley is a car, the moment you hold the keys in your hand.

And cash is just a bunch of meaningless pieces of paper, until you trade it for goods/services. That doesn't mean it's not income.

[The Real Bill]

The tax laws are stupid; that's a given. These people were probably trying to keep the stock for a year so that they'd only have to pay capital gains tax instead of normal income tax (more stupid laws for a stupid distinction--why does someone pay less tax for sitting on their ass as opposed to working it off?). They got burned. My wife exercised options and sold them right away to avoid what happened to these people. It took us all of about 15 minutes of searching the Web to find the relevent tax info--no tax lawyer or financial planner was necessary.

BTW, I like the AMT (given the current tax system; yes, taxes are bad). I'm sick and tired of people making twice as much as me paying less in taxes because they can afford a mortgage and take advantage of other BS deductions that I'm too poor to take advantage of.

[Jim Lippard]

T: You're the one who doesn't seem to understand, as your argument makes no sense.

Put aside incentive stock options for a moment and look at nonqualified options, which have no AMT implications. If a company gives you nonqualified options to buy shares of stock at an exercise price of $1, and you purchase shares currently trading at $100, you are taxed on the difference at the time of exercise, as ordinary income. (Your basis in the stock is then $100/share.) Your argument should work equally against that, saying that this is "imaginary" gain at an "arbitrary" time, right? If not, why not?

Using the Bentley analogy, you're saying that if the company gives it to you when it's worth $100,000, and you sell it after running it into the ground for $10,000, then you've only received $10,000 in income rather than $100,000. Why do you think that it's only income when it's converted back to cash?

And why do you think options have no value? Do you think everyone buying and selling options is insane?