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Make the Minimum Tax Credit a fully refundable credit in the year the stock is sold.

1. Problem Statement

For a middle- or lower-income taxpayer, in a situation where the value of the stock falls significantly from the date of exercise, current law requires a gross overpayment of tax in the form of AMT. Because of the manner in which the Minimum Tax Credit is applied, the credit may take several years, even decades to recover. This happens because the Minimum Tax Credit is not a refundable credit and may only be applied to the excess of a taxpayer’s regular tax liability over his/her alternative minimum tax liability (tentative minimum tax). While this creates extreme financial hardship for middle- and lower-income taxpayers, it is not the case for a highly paid taxpayer who may recover the AMT paid almost immediately.

In the examples below, two employees with identical option exercises end up in totally different situations solely because one earns more income than the other. Both exercise ISOs and must include $500,000 in AMTI for 2000. Both sell the stock in 2001 at their exercise price, realizing no gain or ordinary income for regular tax purposes and reporting a $500,000 negative adjustment for AMT purposes. John, an engineer with an annual salary of $75,000, pays AMT of $146,036 and receives a minimum tax credit in that same amount. It will take John more than 44 years to recover the AMT paid. Erica, in contrast, is a company executive with an annual salary of $450,000. For exactly the same exercise, Erica pays AMT of $120,110 (almost $26,000 less than John pays) and can recover the AMT paid in one year.

2. Proposed Solution

Change current law to make the portion of the Minimum Tax Credit due to an ISO exercise a fully refundable credit in the year in which the ISO stock is sold.

Exempt the ISO gain on exercise from the Alternative Minimum Tax.

3. Problem Statement

While the intent of the law is to encourage employee stock ownership, many employees are forced to sell their stock in order to pay the tax. This results in lower company stock ownership, contrary to the law’s intent.

4. Proposed Solution

Change the law to NOT require the gain on exercise of ISOs to be included in Alternative Minimum Taxable Income (AMTI). This is essentially the change sought by HR 1487.