Relief in Sight for Families Hit by Taxes on ISO Income

Published October 8, 2008

Two pending U.S. Senate bills include relief from the unintended consequences of the Alternative Minimum Tax (AMT) on incentive stock options (ISOs), giving hope to workers who have been hit with huge tax bills for income they never received.

Thousands of employees and their families have been struggling for years with large tax liabilities imposed on “phantom income” when they exercised ISOs that lost their value in the stock market downturn in early 2000. Although these families never realized the gains on which they were taxed under the AMT, the IRS has demanded full payment and imposed interest and penalties that taxpayers have been unable to pay.

The IRS has garnished wages and seized homes, retirement accounts, and children’s education accounts.

Competing Bills Offered

ISO AMT relief restoring proportional taxation based on gains actually made and abating interest and penalties was included in the Jobs, Energy, Families, and Disaster Relief Act of 2008 (S 3335), introduced by Senate Finance Chairman Max Baucus (D-MT) and Senate Majority Leader Harry Reid (D-NV). The ISO AMT relief provision was included as Section 203 in Title II, Subtitle A – Alternative Minimum Tax.

ISO AMT relief also was included under Title I – Alternative Minimum Tax Relief, Section 103, in the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (S 3098), introduced by Sen. Mitch McConnell (R- KY) with Sens. Charles Grassley (R-IA), Jon Kyl (R-AZ), and Orrin Hatch (R-UT).

The Senate ISO AMT relief provisions are identical to the provision included in the Renewable Energy and Job Creation Act of 2008 (HR 6049), which the House passed in May.

Bipartisan Appeal to IRS

Grassley and Sen. John Kerry (D-MA) recently wrote to IRS Commissioner Douglas Shulman requesting his cooperation to prevent further harm to taxpayers when relief legislation is so close to passage. The letter, signed by four Senators and 23 members of the House of Representatives, went to Shulman on July 3.

“We are writing to request your assistance in protecting taxpayers from the unintended consequences of a well-intentioned but misguided tax policy,” the lawmakers wrote. “Many families around the country have been caught by what is referred to as the Incentive Stock Option (ISO) Alternative Minimum Tax (AMT). …. We are currently working to help these ISO-AMT families through the enactment of H.R. 3861, the AMT Credit Fairness and Relief Act of 2007 and its companion bill S. 2389.”

The letter concluded with an appeal to Shulman: “There is now a strong bicameral commitment to enact legislation that accomplishes these goals in the near term this year. In light of that commitment, we are writing to ask that you use the discretion provided the IRS by its effective tax administration authority to suspend efforts to collect ISO AMT liabilities while Congress acts to fix this situation.”

Taxpayer Advocate Urges Change

National Taxpayer Advocate Nina Olson has been a longtime supporter of ISO AMT legislative relief. The National Taxpayer Advocate is employed by the IRS to work on behalf of taxpayers, including by identifying ways the IRS can improve its treatment of taxpayers.

Olson has been assisting taxpayers with ISO AMT liabilities since the problem arose in 2000. Her Fiscal Year 2009 Objectives Report to Congress, issued last June, expressed the continued commitment of her office to “work with the IRS to help taxpayers with the ‘ISO AMT’ problem.”

Olson’s report noted, “[a] number of bills would resolve the problems facing many taxpayers with outstanding ISO AMT liabilities, by abating the liabilities, along with the associated penalties and interest” (referencing H.R.3861 and companion S.2389).

“The National Taxpayer Advocate urges the Congress to pass such a provision as quickly as possible,” Olson wrote in the report.

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