Congress Moves to Fix Tax Penalties Against Incentive Stock Options

Published March 1, 2008

Congress is finishing work begun in 2006 to remedy an unintended consequence of the Alternative Minimum Tax (AMT)–the treatment of a form of employee compensation called incentive stock options (ISOs). (See “Taxpayers Cry Foul as AMT Affects Millions of Americans,” Budget & Tax News, May 2007.)

The proposed legislation would fully restore the economic incentives and benefits Congress intended for ISOs when it allowed companies to offer them beginning in 1981. Under the AMT, thousands of workers who received incentive stock options have faced enormous unintended tax liabilities.

Additional Relief Proposed

ISO AMT relief legislation introduced in 2007 is now moving through Congress. It addresses two remaining critical elements of equitable relief:

  • Removal of limits on overpayment refunds to employees with incomes above AMT deduction phase-out amounts. These employees still cannot recover their ISO AMT overpayment credits.
  • Help for thousands of families who were unable to pay their ISO AMT liability by immediately abating unpaid liability, interest, and penalties. These families have struggled for almost eight years with ongoing liability and significant accrued interest and penalties (accruals). The 2006 legislation does not stop the IRS from demanding full payment of all liabilities including accruals, and the employees will lose forever the interest and penalty amounts paid.

High-Tech Left Out

Families living in high-technology corridors, which are typically high cost-of living areas, were disproportionately left out of the 2006 relief. Recognizing that reality, Lezlee Westine, CEO of TechNet, expressed the firm’s commitment to comprehensive fair relief.

“We look forward to working with the Coalition [for Tax Fairness] and Congressional leadership to extend this much-needed relief to all families in key regions where employees were hit particularly hard, including Silicon Valley, Northern Virginia, Massachusetts, and the Maryland high-tech corridor,” Westine said.

The 2007 ISO AMT relief bill (H.R. 3861) was introduced in the House by Rep. Chris Van Hollen (D-MD) and lead Republican co-sponsor Rep. Sam Johnson (R-TX), with original co-sponsors Rep. Richard Neal (D-MA) and Rep. Jim Ramstad (R-MN).

In the Senate, the measure was introduced by Sen. John Kerry (D-MA) with original co-sponsors Sen. Maria Cantwell (D-WA) and Sen. Joseph Lieberman (I-CT).

The legislation is expected to be enacted this year.

In a news release, Van Hollen stated, “The goal of this legislation is to restore a basic sense of fairness to a provision in the tax code that has gone tragically awry.

“While everyone should pay a just and proportionate amount of tax on money they actually make,” Van Hollen continued, “no one should lose their homes, savings, and retirement to a wildly disproportionate tax on phantom income they never saw, because our tax laws failed to anticipate the circumstances in which a number of our citizens now find themselves.”

Relief Expected in 2008

The 2007 ISO AMT relief bill quickly gathered bipartisan and broad geographic area support and was included in the first two “AMT patches” passed by the House in November and December 2007.

Kerry’s identical counterpart bill (S. 2389) was co-sponsored by Sen. Maria Cantwell (D-WA), Sen. Joseph Lieberman (I-CT), and Sen. Barbara Boxer (D-CA), demonstrating strong support for this second phase of ISO AMT relief in America’s high-tech corridors and technology incubator regions.

This full relief came close to being included in the final AMT patch passed by the Senate and House in mid-December 2007 but was ultimately deferred to 2008.

Tim Carlson ([email protected]) is president of the Coalition for Tax Fairness. Brian Trauman ([email protected]) is an attorney specializing in tax issues at Mayer Brown LLP in New York City.