The
gnarliest, most
evil tax in
all the land. The
alternative minimum tax is supposed to close a set of
loopholes in the
tax code that allowed
rich people to
cheat on their
taxes.
I suppose that makes me
rich, then. Or, at least, I was, until I had to pay the
tax.
The way
alternative minimum tax works is subtle. You work at a
startup. You get
stock options (a particular kind of stock option called an
incentive stock option, in fact, is the only way this happens). Usually your
strike price is very low, less than one dollar per share, but since the company is private, the stock isn't
liquid. Later on, the company goes public (
IPO!), or is acquired by a
public company. Now your startup-stock is worth real money. You are "
rich."
You decide to
exercise your options and hold onto the stock, because you think the
company is a good one, and will grow and grow, along with your stock. Because you have
incentive stock options, you can do this. However, here comes Mr.
AMT to whack you. When you next pay your taxes, you have something called an
AMT preference item equal to the "gain" you realized when you exercised the option. If after the
IPO, your stock is at 15 dollars, and your price was one dollar, the
IRS thinks you made 14 dollars per share, even if YOU DIDN'T SELL THE STOCK so YOU DON'T HAVE THE MONEY. You owe this tax many months later (on April 15) -- and if you are trying to hold onto to your shares to get
long-term capital gain treatment for them (which is supposed to be the responsible way to invest), you may have tried to do this deal in March of 2000, when your stock was even higher. Ironically enough, this was the high point for the US
stock market, and most stocks have fallen by more than 70-80% in value in the last 6 months.
Now, your federal tax
liability is 28% of the 14 dollars gained, which is about $3.50, but the stock is trading at $2. You did this for many tens of thousands of shares, so your tax bill is many hundreds of thousands of dollars, and the stock you own is worth much less than that now. And of course, the great state of
California also has
AMT, at a lower rate, that adds another 7-8% to what you owe.
Bankruptcy starts to look good. Unfortunately debts to the
IRS are not cleared by
personal bankruptcy.
The totally
ludicrous thing is that there is no way to re-value the "
gains" you never realized, based on current market conditions (i.e. tax me based on the share price I actually have today -- which I by definition could afford to, and would willingly pay). If the
tax code did this, no one would have a problem.
But, it doesn't, and now I know more about
option collars, derivative-based
hedge structures, and
tax attorneys than I care to. And I have a lot of
bankrupt friends. Sigh.
Apparently
dubyah is talking about repealing
AMT, but not retroactively.
Postscript: I am not a proponent of the flat tax, as some have accused me. I'm perfectly willing to pay my share -- but my marginal tax rate of nearly 200% of W-2 income, well that doesn't quite seem right. See also
The Parable of the Tenth Man.
Thanks to
_Yup for pointing out a typo.