Employees of dot.com companies have been struggling with the weight of the alternative minimum tax on stock options they exercised. The employees were given qualified incentive stock options (ISOs). ISOs are not taxable when exercised. However, the spread between the stock's value and the option's exercise price is subject to the alternative minimum tax (AMT). That spelled big tax problems for thousands of taxpayers.

The Tax Relief and Health Care Act of 2006 has finally provided these dot.com employees with some relief. The new law provides a refundable AMT credit that can be taken against ordinary income. However, do not confuse this specific relief with general AMT reform that's been talked about in Washington for several years but, so far, has gone nowhere. Most taxpayers subject to the AMT are not helped by this new provision; but most taxpayer advocates believe that this is a step in the right direction.

Background.  When there is a "deferral adjustment" or timing difference to the AMT calculation, this creates a minimum tax credit (AMT credit) that can reduce the taxpayer's regular tax liability in a subsequent year. For example, AMT may be paid on all of the gain from an installment sale. The credit amount is equal to the excess of the AMT over the regular tax paid in the year of the sale. In a later year, when regular tax is paid on an installment, the credit reduces the regular tax liability by the AMT paid in the previous year. The AMT credit could be carried forward indefinitely but was not refundable. Furthermore, the AMT credit cannot offset AMT liability. Thus, the large AMT credit generated by ISOs of dot.com employees was not of any use.

New tax law.  Under the new law, the AMT refundable credit amount is the greater of (1) the lesser of $5,000 or the long-term unused minimum tax credit, or (2) 20 percent of the long-term unused minimum tax credit. The long-term unused credit is the minimum tax credit for the fourth year or older that precedes the current year. The taxpayer can take a portion of the refundable credit each year.

Example.  B owes regular tax of $45,000 and a tentative minimum tax of $40,000. B has a long-term unused minimum tax credit of $1 million (due to incentive stock options for which the stock was in the stratosphere when issued but "tanked" by the time B was able to exercise them). The AMT refundable credit amount is $200,000 (20 percent of the long-term unused credit). B's minimum tax credit offsets $45,000 of B's regular tax liability. The refundable credit amount is $155,000 ($200,000 minus $45,000), which is paid to B as a refund or credit. The remaining $800,000 minimum tax credit carries forward to future years.