AMT related to Incentive Stock Options

To comply with Internal Revenue Service Circular 230, we inform you that any tax advice contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.

If you are one of the (lucky!) individuals who has Incentive Stock Options, you are probably concerned about your hefty AMT bill once you exercise, and probably when you sell, if your capital gains are high enough.  There are some basic guidelines to know about to ease your mind, or at least assist you in planning for these transactions.

The fundamental difficulty with ISOs is that when the fair market value (FMV) is low, conventional wisdom says not to exercise, or buy, the stock from the company you’re working for, since you could lose all your capital if your company goes under or doesn’t go public.  But when the fair market value is high, your company is doing well (presumably), and you could make a lot of money if you sell your stock.  Unfortunately, in the latter case, you might be subject to the AMT since the difference between the FMV and your exercise price is taxable under AMT rules.
If you would like to exercise your stock but either don’t have the capital to actually make the payment to your company, or don’t have the money to pay the AMT bill, or both, consider speaking to a local bank, preferably a regional bank that may not have as strict rules as a large multinational bank, about lending you the money for your transaction.  If you can line up a buyer, or if your company is already publicly traded, the bank’s risk is substantially lowered, since they could require you to have an offer letter from a buyer before you even exercise, thus almost guaranteeing return of their investment.
If you are particularly worried about your AMT bill, you will probably need to sell your shares in the same year that you exercise.  That way you won’t be on the hook for the AMT for one or more years until you sell the shares and can recoup some of your taxes that you paid upfront (If you are in this situation, be sure to file IRS form 8801 for the AMT credit for every subsequent year after you pay the AMT on the exercise of stock options in order to claim the credit in future years. Keep in mind you can only claim this credit in a year when you aren’t subject to the AMT.).  The downside of this strategy is that you will have to pay short-term capital gains tax, which is much higher than long-term capital gains.  However, this is typically thought of as the least riskiest route to take, since you know when you exercise that you will be able to sell the shares for a profit.
However, if you have nerves of steel, along with time and money on your hands, exercise early when your stock’s FMV is low!  This is risky, as I mentioned before, since you could lose all of your investment, along with your job, if your company goes under.  However, if you’re working at a startup, you probably already have a higher than average risk tolerance and may be the ideal type of investor to take on this risk.
Good luck, and be sure to consult a tax professional if you have exercised ISOs and need to determine your tax liability related to these types of transactions.

Strategies for Reducing Your AMT Bill

To comply with Internal Revenue Service Circular 230, we inform you that any tax advice contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.

The first question anyone asks who has faced an AMT bill is “How can I reduce it?”.  The easiest way is to reduce your AGI.  This can be done by increasing or maxing out your 401(k) contributions for the year (or 403(b), 457(b), or SIMPLE IRA contributions).  Also, if your employer offers a cafeteria plan, you can reduce your AGI by paying for medical, dental, life, and disability insurance, as well as dependent care expenses.

Other AMT minimization strategies are mostly for self-employed people and business owners.  If you have self-employment income, be sure to claim business expenses directly against that income on your Schedule C instead of as miscellaneous itemized deductions on Schedule A.  This way, you won’t lose any of the deductions when you compute your tax bill under AMT rules.  If you do have self-employment income, consider claiming a home office deduction (but be sure you have thorough documentation to support this deduction, since it is a common audit flag for the IRS).
Since itemized deductions are mostly eliminated under AMT rules, try to time real estate, state income, and other tax payments during years when your income won’t put you into AMT territory.
One last strategy to reduce the AMT is through charitable contributions.  Charitable contributions are still deductible under the AMT, but you will probably end up paying more total dollars out of pocket; a portion of the money will just go to a charitable cause rather than to Uncle Sam.
The AMT is very complex, so please be sure to consult a tax professional if you do end up owing the AMT!

Common Alternative Minimum Tax (AMT) Triggers

To comply with Internal Revenue Service Circular 230, we inform you that any tax advice contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.
 
If you found yourself paying the AMT the last couple of years or think you might have to pay it this year, it can be useful to understand what some common AMT triggers are.  The AMT (Alternative Minimum Tax) is a parallel tax system that replaces the regular tax code that applies to your return if you exceed certain limits.  Often the AMT kicks in if you have a lot of itemized deductions or certain types of income that are tax-free under the regular tax system.
Some common AMT triggers are:
-high amount of state and local taxes
-high number of personal exemptions
-medical expenses
-unreimbursed employee expenses (miscellaneous expenses)
-exercise of ISOs (incentive stock options)
-interest on home equity debt used for purposes other than buying, building, or improving your home
-accelerated depreciation
-long-term capital gains
-tax-exempt interest from private activity bonds
-passive income or losses
-net operating loss deduction
There are many other possible AMT triggers, but identifying one or more of these common expenses or types of income as the culprit behind your AMT bill is the first step in making important tax planning decisions.  Once you understand the drivers behind your tax liability you can improve both your short- and long-term investment and tax strategies.

Take Advantage of your W-4

To comply with Internal Revenue Service Circular 230, we inform you that any tax advice contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.

If you end up owing a large amount in federal or state taxes at the end of every year, or receive big refunds, you should consider updating your W-4 with your company (if you are self-employed, see post on making estimated payments).  You can complete a pro-forma tax return with estimates of your income, exemptions, deductions, etc., and contribute any extra amount you think you will owe.  To do this, run the pro-forma (or have an accountant do it), and divide the additional amount you will owe by the remaining paychecks you have in the year.  Your company should allow you to designate an additional amount in federal and/or state taxes that you want withheld on each paycheck.  If you typically receive a big refund, consider taking more allowances so you have less money withheld.  It is always best to come as close as possible to a zero dollar refund or payment each tax year so that you are not giving the government a no-interest loan all year, or are not pulling from your savings to make big tax payments.

Assessing your risk of underpayment penalty

To comply with Internal Revenue Service Circular 230, we inform you that any tax advice contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.
 If you have owed or come close to owing an underpayment penalty to the IRS in past few years, you may want to assess your tax liability for the year.  It is not too late to eliminate or mitigate your risk of owing an underpayment penalty for 2013.
1.  The general rule is you won’t have to pay a penalty if any of the following situations apply to you:
a.  your withholding and timely estimated tax payments are at least as much as your taxes due the prior year (110% of last year’s tax if your prior year AGI was more than $150K/$75K for married filing separately), or
b.  your tax balance due is less than 10% of your total tax bill for the year
c.  your total tax minus withholding is less than $1000
d.  you did not have any tax liability the prior year.
2.  You may have to pay a penalty if the total of your withholding and estimated tax payments is smaller than the lesser of:
a. 90% of your current year tax, or
b.  100% of your prior year tax (110% if your AGI in prior year was over $150K/$75K for MFS).
3.  Remember that you might still be assessed an underpayment penalty if you owed taxes in one payment period but paid them later in the year, since the penalty is calculated separately for each period.
If you think you might be at risk of owing an underpayment penalty, contact us today to determine what you owe!  Even if you make a late payment, the sooner you make that payment, the lower your overall penalty will be.