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Historical Background and Reasons for Reform

A brief outline of the History of the Alternative Minimum Tax (AMT) can be found in an article by Amity Shlaes.

A. Foundation for effecting reform

In seeking to change existing tax law, it is important to understand the original intent of Congress. Assuming there were good reasons that motivated their predecessors to take the action they did, most members of Congress will ask the question of why the current law is as it is before voting to change. Effecting change, then, is often predicated upon either demonstrating that the current law no longer produces results consistent with the original intent or that the original intent is no longer a desired end.

B. Incentive Stock Options

Incentive Stock Options, although technically established by the Economic Recovery and Tax Act of 1981, can trace their history back to the Restricted Stock Options authorized by the Revenue Act of 1950. So there is actually a half-century of tradition and legislative history behind the concept of ISOs. They were originally established and continue to exist to encourage employees to own stock in their company, based upon the belief that aligning employee interests with those of stockholders is good for the economic well being of the company and, thereby, for our economy as a whole. We believe this was and continues to be sound reasoning. An employee who has a meaningful ownership stake in the company will consider the good of the company and not look solely to his or her own interests. This produces stronger, healthier companies, which, in turn, are the foundation for a strong, healthy economy.

C. Alternative Minimum Tax

Both the Alternative Minimum Tax and its predecessor, the Add-on Minimum Tax, were intended to require all taxpayers to pay their fair share of taxes. The concern expressed by Congress was that wealthy taxpayers, because of their wealth and access to resources, were able to employ tax strategies or invest in tax shelters that allowed them to reduce or practically eliminate their income taxes. This was seen as unfair and discriminated against people of ordinary means who then ended up paying a proportionately larger percentage of their income in taxes. What lawmakers had in mind in subjecting ISOs to AMT were wealthy, senior executives with high six- and seven-figure salaries who choose to take several million more in the form of ISOs.

D. Rationale for Reform

The most important recent change is the trend towards broad based stock option grants. This, we believe, is one of the strongest effective arguments for any current effort for change. The current law was put in place at a time when stock options in general and Incentive Stock Options in particular were granted only to the senior executives of large, public companies. Lawmakers did not envision the broad based option programs of today and, as a consequence, did not consider how the law would affect middle- and lower-income taxpayers.

We believe the strongest argument for reform is as follows:

  • Current law was drafted at a time when stock options, in general, were granted only to a very few, top executives in large, public companies. Its intent was to require wealthy highly compensated taxpayers to pay what lawmakers considered a fairer share of their income in taxes. Those who are wealthy can afford to pay their AMT (without having to sell their stock) and those who are highly compensated can recapture the AMT paid when they do sell their stock.
  • However, since the time when the law was originally enacted, things have changed. Today, many middle- and lower-income taxpayers also have been granted incentive stock options and current tax law is having an unintended effect on them.
  • While a wealthy taxpayer can exercise ISOs and pay the AMT without the need to sell stock to do so, most middle- and lower-income taxpayers must sell their stock to pay the tax. Contrary to the original intent of the law, rather than encouraging stock ownership, the law discourages ownership by placing these taxpayers in a position where they must sell their stock.
  • While a highly-compensated taxpayer who pays AMT on stock that later falls dramatically in value can recover the AMT paid (by action of the minimum tax credit) by simply selling the stock, it may take years or decades for a middle- or lower-income taxpayer to recover the tax paid. Contrary to the original intent of the law, middle- and lower-income taxpayers are being forced to pay an unfairly high share of taxes.
  • In short, because of changes in compensation practice, namely the granting of stock options to a much broader cross-section of employees, current tax law discourages stock ownership and imposes severe financial hardship on middle- and lower-income taxpayers. These are unintended consequences of the law and immediate change is needed.