A provision of the 2006 legislation addressing unintended tax penalties on incentive stock options (ISOs) under the Alternative Minimum Tax (AMT) is proving counterproductive, because it limits overpayment refunds to employees with incomes above AMT deduction phase-out amounts.
The phase-out rule forces some of America’s most experienced and productive employees to scale back their productivity or quit work entirely. If an employee forgoes some income to get under the phase-out level, the AMT credit received will be larger than the income given up.
This rule turns ISO compensation–intended by Congress to stimulate economic growth–into a strong disincentive against economic growth.
In his analysis of the 2006 ISO AMT relief legislation, tax lawyer, author and publisher Kaye Thomas noted, “Perhaps the most striking aspect of the [2006 legislation] is the poorly designed phase-out rule. Within certain ranges of income people will face a marginal tax rate greater than 100 percent if their unrecovered credit is large enough.”
Thomas noted, “This phase-out has implications that are positively mind-boggling. … Unless Congress changes this rule, many people in this situation will have to limit their income to an amount at or below the bottom of the phase-out range.”
Thomas said the rule could have life-changing effects on taxpayers. “The consequences of this phase-out rule are potentially so powerful that some people might rethink their careers,” he stated in his analysis. “What would you do with your life if a $100,000 cut in pay allowed you to recover an extra $150,000 per year in AMT credit over the next several years? Take a sabbatical? Switch to a more satisfying but lower paying job? Retire early?”
In November 2007, Sen. John Kerry (D-MA) introduced a bill identical to a House bill introduced by Rep. Chris Van Hollen (D-MD) to eliminate the phase-outs. Kerry explained, “This legislation will help refund taxes to those who were unfairly burdened. … In turn, these workers will be able to invest in new businesses and companies that will help keep our … economy strong.”
— Tim Carlson and Brian Trauman