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Alternative Minimum Tax on Incentive Stock Options
Updated: June 4, 2003

Issue:

Incentive stock options (ISOs) encourage employees to have a long-term stake in their companies. An added benefit is the fact that the exercise of an ISO generally does not result in a taxable event. This benefit is in contrast to the exercise of a nonqualified stock option, which results in the immediate recognition of income, even if the stock acquired by exercising the option is not sold.

Both established companies and small entrepreneurial ventures use stock options to attract and retain their employees.

National Perspective:

The benefit of ISOs is undermined by unfavorable treatment of ISOs for alternative minimum tax (AMT) purposes. Under the AMT, the gain between the grant price and the exercise price is treated as a preference item to be included in AMT income. In effect, the AMT causes an acceleration of the taxable event for an ISO.

For regular tax purposes, there is no taxable event until the ISO shares are sold, but the AMT causes a portion of the total tax to be moved up to the year of exercise. This result discourages employees from holding their options as a stake in their companies and for the period required to obtain favorable capital gains treatment.

Because AMT calculations are complex, many employees who have exercised ISOs but who have seen the market value of their options decline below the exercise price, are now faced with significant AMT tax liability without having the resources needed to meet this liability.

Governmental Activity:

Massachusetts Congressman Richard Neal filed legislation that would limit the AMT on ISOs exercised during 2000 to the fair market value of the stock as of April 15, 2001, or, if the stock was sold before then, to the amount realized on that sale.
Senator John Kerry sought to include a provision providing AMT relief for ISOs in the Senate version of the economic stimulus legislation, but the issue was unresolved when the Congress adjourned at the end of 2002, without the Senate having taken up the stimulus legislation.

Software Council Position:

The Council supports enactment of legislation providing relief from the AMT for ISOs because employees should be encouraged to acquire and hold stock in their employers. ISOs should be subject to tax upon their sale, not upon their exercise.

Software Council Activity:

The Software Council has collaborated with the EMC Corporation in working with Congressman Neal and Senator John Kerry to seek relief from the AMT for ISOs.

The Council urged all Members of the Massachusetts Congressional Delegation to co-sponsor the legislation filed by Congressman Neal and Senator Kerry.

The Council submitted a statement to the House Ways & Means Committee for inclusion in the printed record of a hearing the Committee held on Tax Code Simplification, noting that the harmful consequences of AMT complexity adversely impact the employees of many companies, large and small.

Forty Massachusetts companies have authorized the Council to record their opposition to the AMT being applied to ISOs. Of these forty companies, thirty-four grant ISOs to more than eighty per cent of their employees.

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