Alternative Maximum Tax Again!
Around this time last year, I wrote a post about what I call the Alternative Maximum Tax. (Yeah, I know the post is dated in September, but that's the date that I transferred it to this blog server, not when I really wrote it!)
It turns out that the AMT is even worse than I realized then. You see, one thing that triggers the AMT is future income that is likely but has not yet been realized. And when that income actually occurs sometime in the future, if the original estimate was too low, then you immediately owe tax on the excess. But if the original estimate was too high, then Uncle Sam will credit your tax overpayment back you, not all at once, but bit by bit over several years. Nice, huh?
Let's say that you make reservations for 20 at some fancy restaurant. But in order to accept such a reservation, the restaurant required you to put up a deposit for the price of, not 20, but 30 steak dinners a couple of months in advance. The date rolls around, and what do you know, your party consumed 20 steak dinners just like you expected, so you have paid for 10 dinners you never got, and what's more the restaurant has been holding that money for two months. So they say, "Here's your refund." You look at the check, and it is the price of only 5 dinners. When you ask about the amount, they claim that they're holding the deposit just in case you consume more in the future. They will refund you for 3 more dinners in a few months if you haven't used them yet, and refund you for the last 2 dinners a few months after that.
Is that illustration silly? Of course it is, but that is essentially what happened to my taxes. You see, part of my employer's compensation program consists of blocks of options on the company's stock. (At least it used to be a part; not so much any more.) Each option represents the right at some time in the future to buy a share of stock at today's market price, regardless of what the price will be by then. The catch is, it's in the future, at least a year away, and sometimes as much as five years away. It's supposed to be an incentive to help the company succeed so that when your options are vested (matured), the stock price is significantly higher than the price you have to pay. (Sometimes the price is lower, which makes the option worthless.) Well, the easiest way to use stock options is to do a "same-day sale", where your broker essentially lends you the money to buy the stock from the company at the option price so that you can turn around and immediately sell it on the open market at the current price. The broker actually just sends the company enough of the sale proceeds to cover your option price and then sends you the remainder.
The problem with a same-day sale is that the remainder check that the broker sends you becomes regular W-2 income, and is therefore taxed at same rate as your "wages, tips, and other compensation". However, if you instead dig into your own checking account to come up with the money to buy stock at the option price, and then hang onto that stock for at least a year before selling it on the open market, any profit you make on the sale will be taxed at the much-lower long-term capital gains rate.
Here is where the evil of the AMT kicks in. (Remember, I'm really writing about AMT, not stock options.) In 2004, I decided to try this capital gains savings, and went ahead and forked over the cash to get some stock at the option price. Then, when working on the 2004 Form 1040 in spring of 2005, the AMT rules said that that stock was now income. Even though I have not yet received a penny of such income, for AMT calculations I had to assume a long-term gain by selling the stock at the market price of the day I bought it. So I had to fork over quite a few $ on April 15, 2005.
Later in 2005, I needed the cash that the stock represented, so shortly after the one-year mark, I sold it. But the market price when I sold it was lower than when I bought it, so although I did make a profit on the sale, I didn't make as big a profit as I had already paid taxes on back in April. So Uncle Sam should owe me a credit for that tax overpayment.
Come February of 2006, I'm working on 2005 taxes and it turns out that the AMT rules won't let me recapture all of the overpayment; I get some of it back immediately and have to roll the rest over to 2006 taxes. So the government has already been holding tax payments for nearly a year on income that has never existed and never will, but I can't get all of it back yet.
Oh, and we moved during 2005, and due to some strange gyrations of our county's property tax system, we wound up paying a full year's real estate tax on both our old and new home. Somehow I overlooked that detail when itemizing deductions for 2005, so when it came to my notice, I had to file an amended return, Form 1040X. But as it turns out, that extra property tax did not increase our 2005 refund by even a penny; it merely increased the AMT recapture rollover into 2006.
So now here it is February 2007, and I've done all 2006 taxes. Guess what? I still don't get all of my AMT back. There's still a few hundred dollars that have to roll over into 2007 taxes next year. (Sigh.)
I don't have many stock options left, but I will not do another exercise-and-hold on them. (That's what the broker calls what I did back in 2004.) The AMT just makes it totally not worth it.
It turns out that the AMT is even worse than I realized then. You see, one thing that triggers the AMT is future income that is likely but has not yet been realized. And when that income actually occurs sometime in the future, if the original estimate was too low, then you immediately owe tax on the excess. But if the original estimate was too high, then Uncle Sam will credit your tax overpayment back you, not all at once, but bit by bit over several years. Nice, huh?
Let's say that you make reservations for 20 at some fancy restaurant. But in order to accept such a reservation, the restaurant required you to put up a deposit for the price of, not 20, but 30 steak dinners a couple of months in advance. The date rolls around, and what do you know, your party consumed 20 steak dinners just like you expected, so you have paid for 10 dinners you never got, and what's more the restaurant has been holding that money for two months. So they say, "Here's your refund." You look at the check, and it is the price of only 5 dinners. When you ask about the amount, they claim that they're holding the deposit just in case you consume more in the future. They will refund you for 3 more dinners in a few months if you haven't used them yet, and refund you for the last 2 dinners a few months after that.
Is that illustration silly? Of course it is, but that is essentially what happened to my taxes. You see, part of my employer's compensation program consists of blocks of options on the company's stock. (At least it used to be a part; not so much any more.) Each option represents the right at some time in the future to buy a share of stock at today's market price, regardless of what the price will be by then. The catch is, it's in the future, at least a year away, and sometimes as much as five years away. It's supposed to be an incentive to help the company succeed so that when your options are vested (matured), the stock price is significantly higher than the price you have to pay. (Sometimes the price is lower, which makes the option worthless.) Well, the easiest way to use stock options is to do a "same-day sale", where your broker essentially lends you the money to buy the stock from the company at the option price so that you can turn around and immediately sell it on the open market at the current price. The broker actually just sends the company enough of the sale proceeds to cover your option price and then sends you the remainder.
The problem with a same-day sale is that the remainder check that the broker sends you becomes regular W-2 income, and is therefore taxed at same rate as your "wages, tips, and other compensation". However, if you instead dig into your own checking account to come up with the money to buy stock at the option price, and then hang onto that stock for at least a year before selling it on the open market, any profit you make on the sale will be taxed at the much-lower long-term capital gains rate.
Here is where the evil of the AMT kicks in. (Remember, I'm really writing about AMT, not stock options.) In 2004, I decided to try this capital gains savings, and went ahead and forked over the cash to get some stock at the option price. Then, when working on the 2004 Form 1040 in spring of 2005, the AMT rules said that that stock was now income. Even though I have not yet received a penny of such income, for AMT calculations I had to assume a long-term gain by selling the stock at the market price of the day I bought it. So I had to fork over quite a few $ on April 15, 2005.
Later in 2005, I needed the cash that the stock represented, so shortly after the one-year mark, I sold it. But the market price when I sold it was lower than when I bought it, so although I did make a profit on the sale, I didn't make as big a profit as I had already paid taxes on back in April. So Uncle Sam should owe me a credit for that tax overpayment.
Come February of 2006, I'm working on 2005 taxes and it turns out that the AMT rules won't let me recapture all of the overpayment; I get some of it back immediately and have to roll the rest over to 2006 taxes. So the government has already been holding tax payments for nearly a year on income that has never existed and never will, but I can't get all of it back yet.
Oh, and we moved during 2005, and due to some strange gyrations of our county's property tax system, we wound up paying a full year's real estate tax on both our old and new home. Somehow I overlooked that detail when itemizing deductions for 2005, so when it came to my notice, I had to file an amended return, Form 1040X. But as it turns out, that extra property tax did not increase our 2005 refund by even a penny; it merely increased the AMT recapture rollover into 2006.
So now here it is February 2007, and I've done all 2006 taxes. Guess what? I still don't get all of my AMT back. There's still a few hundred dollars that have to roll over into 2007 taxes next year. (Sigh.)
I don't have many stock options left, but I will not do another exercise-and-hold on them. (That's what the broker calls what I did back in 2004.) The AMT just makes it totally not worth it.
Labels: Tax Rant
posted by Steve | 11:18 AM
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