AMT and Equity Compensation
Alternative minimum tax, nonqualified stock options, incentive stock options and other forms of equity compensation.
Double taxation on disqualifying disposition of ISO
Posted by: LARunt, February 3, 2016 08:02AM
In 2014, I exercised some ISOs, and paid my AMT on the value between the fair market value and the exercise price. In 2015, I sold some of these shares, and my (now former) employee sent me a W2 with the (sale price - exercise price) of the sold shares in the wages box. Regardless of the capital gain / loss resulting from the sale, the amount I paid 2014 AMT on is now being taxed again as wages in 2015. Is this really the way it's supposed to work? Is there a way to declare that I've already paid taxes on this?

Thanks!
Dan

Re: Double taxation on disqualifying disposition of ISO
Posted by: Art, February 3, 2016 10:27PM
You face two different tax regimes/systems, regular income and also AMT.

For 2014 you may have paid AMT due to ISO exercise that did not disqualify before year end 2014. But that exercise did not produce a 2014 regular income amount because at Y/E 2014 you had not disqualified.

In 2015 your disqualifying actions did not result in an increase due to ISO exercise to AMT but did result in an ordinary income tax increase. And the disqualifying action changed the nature of the gain from capital gain to ordinary income for AMT.

I view this as a change in how regular income tax and AMT work together, rather than double taxatiion. To be double taxation, IMO, the double tax on the same income would be within the regular income tax regime or within the AMT regime, and we do not see that.

Re: Double taxation on disqualifying disposition of ISO
Posted by: LARunt, February 3, 2016 11:21PM
Art,
Thanks for the reply. I understand that AMT works with regular taxation in this way, but it has always seemed to me that it was meant to ensure that forms of income were at least taxed once. If you follow the money, so to speak, it seems that this money is being taxed twice. Just to be clear, let's make a simple illustrative example.

In 2014, I paid the exercise price for an option. Let's say $1. The stock was worth at that time the market value, say $11. I paid AMT on the $10 of compensation I've received in this exercise. Later in 2015 (but less than a year after exercise), I then sold that share for $11. There are no capital gains because I've sold it for the market value, but I've also received a W2 for $10 because of the income from that sale. This same $10 is now being taxed a second time.

How is this not double taxation?

I would greatly appreciate some insight on the appropriate way of handling this situation.

Regards,
Dan

Re: Double taxation on disqualifying disposition of ISO
Posted by: Art, February 4, 2016 04:09AM
Trace how the 10 added to your W-2 increases the cost basis of the disqualifying stock for regular income tax purposes.

Re: Double taxation on disqualifying disposition of ISO
Posted by: LARunt, February 4, 2016 04:53AM
Thanks for your response, Art! I'm not sure I understand your request. The cost basis only comes into play in determining the capital gain or loss. My issue is with the $10 being reported on a W2 as if it were wages.

Re: Double taxation on disqualifying disposition of ISO
Posted by: Art, February 4, 2016 10:13PM
Reporting the 10 as income now while increasing basis by 10 cancels out double taxation since down the road the gain will decrease by 10.

I am assuming the W-2 does not have a box 12 code V amount.

Re: Double taxation on disqualifying disposition of ISO
Posted by: LARunt, February 5, 2016 12:37AM
Art, I feel that we are talking past each other. Let me try to explain a different way. Let's imagine I paid $11 of my own money for some standard share of stock. Later I decided to sell it. The stock happened to be at $11 when I sold it. I don't get taxed for the $11 I receive from selling the stock... I'm only taxed not he gain/loss, which in this example is zero since the basis is the same as the selling price.

When I paid AMT in 2014, I paid tax on the $10 inflation of value from a $1 Option to an $11 Stock. From that point on, my story should be just the same as the story above when I purchased an $11 standard share of stock. Yet, in my case, I received a W2 for the $10 received in the sale (minus the exercise price). Yes, the capital gain of this transaction involves looking at the basis. **That's not what I'm confused about.** I'm not confused about the gain. I'm confused about the W2 statement reflecting the sale of this share. This $10 added to my other W2 wages, and gets taxed as normal income, **without regard to the basis**.

Am I incorrect in imagining that this option, now turned stock (after paying AMT) is no different than simply purchasing a standard share? Having paid AMT on the way up from option to share, do I also have to pay tax on the way down when I sell it? Again, I'm not talking about basis or gains. I'm talking about the fact that the sale of this stock ends up on my 1040 taxed as if it were part of my regular wages, effectively taxed a second time. Is there some sort of adjustment so that this doesn't happen? Because it just doesn't seem fair to be taxed twice.

Hopefully this is clear...
Dan

Re: Double taxation on disqualifying disposition of ISO
Posted by: triad, February 5, 2016 02:10AM
Have you heard the phrase "dual basis asset"?

Once you paid AMT, you created one for every share of stock. You also created an AMT credit which doesn't show up until the following year when you fill out an 8801. Many people forget to do the 8801.

Under the normal 1040 rules, your basis is $1. If you had a disqualifying sale, this is bumped to $11 when the $10 is included on the W-2, box 1. On the 1040 schedule D/8949, you show $11 for the cost basis. If the sale was NOT disqualified, you'd show $1.

On the AMT schedule D/8949 (these are implied, but I find it easier to actually do them), you also show the $11 for the cost. If the two schedule Ds show a difference (both are capped at a $3000 loss), you show the difference on the AMT form on the line that says disposition.

THEN you look at the AMT form. If you don't owe AMT, great, because then the AMT credit form 8801 will give you some or all of the money back that you paid when you acquired the stock. The limit on the amount is the difference between the 1040 tax and the AMT tax. If you do owe AMT, you still do the 8801 form to carry the credit forward.

Re: Double taxation on disqualifying disposition of ISO
Posted by: LARunt, February 5, 2016 04:53AM
Thanks a lot, Triad! This helps a lot. I'll take a look into form 8801 to see if this is the solution I'm looking for.

Dan

Re: Double taxation on disqualifying disposition of ISO
Posted by: triad, February 6, 2016 03:53AM
I was lucky. The one time I paid AMT, it was for a modest amount. The following year, I didn't pay AMT and got all of the money back.

However, I got it back by amending. I had missed the part about filing form 8801 the following year and didn't do it when I originally filed. I thought, somehow, that I had prepaid the tax on the capital gain and that I'd get it back when I sold the stock, even if it was 10 years later. Fortunately, I tripped over an article in Money magazine that pointed me to the 6251 instructions before the refund statute ran out.

(I'd already figured out the deal about if you include something as income elsewhere on the return, you add it to the cost basis before doing schedule D. Just don't forget to do schedule D if there is a 1099-B floating around.)


Re: Double taxation on disqualifying disposition of ISO
Posted by: Kaye Thomas, February 6, 2016 08:57PM
LARunt, the rules are designed to prevent you from paying double tax. Generally they're geared toward making sure you end up paying total tax that's the higher of (a) the tax you would pay if only AMT rules applied, or (b) the tax you would pay if only regular income tax rules applied. Often taxpayers end up paying somewhat less than the higher of these two rules.

To achieve the correct result you have to file both Form 6251 and Form 8801 every year until you've fully used whatever AMT credit you created in the year you exercised the option. Properly preparing the 6251 can be tricky when you make a disqualifying disposition after the end of the year in which you exercised the option. In this situation, the amount of compensation income you're reporting for regular income tax purposes on the DQ has to be backed out of your AMT calculation with a negative adjustment on line 17 of Form 6251. In the AMT world, this is an adjustment in ordinary income.

But you may also have an adjustment in capital gain or loss, and this will also appear as part of the adjustment reported on line 17. To figure this adjustment, you first have to determine the amount of capital gain, if any, you have for regular income tax purposes on this sale. You can't have capital loss, because if you were selling the shares at a loss, i.e. for less than the amount of exercise price you paid to buy them, you would not have compensation income in connection with the disposition. If the shares went down in value between exercise and sale date, you have zero gain or loss for regular tax purposes.

Then figure the amount of capital gain or loss for AMT purposes. Here it's possible you have a loss (if share value declined after you exercised) or gain. You need to prepare an AMT version of Schedule D to determine whether the capital loss limitation applies or other gains or losses on your return affect the amount you show here. The end result may be an additional negative adjustment for line 17, which is added to the negative adjustment relating to exclusion of the ordinary income.

The end result of all this is to reduce the amount of income (and possibly capital gain) you report for AMT purposes, which reduces the tax calculated for AMT purposes, which increases the amount of AMT credit you can claim on Form 8801, which eliminates double taxation.

Kaye Thomas
Fairmark.com



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