Incentive Stock Options and the AMT--Woes for Taxpayer
In Robert J. Merlo v. Commissioner, the taxpayer feels the full brunt of the the harshness of the alternative minimum tax in connection with the exercise of an incentive stock option. The taxpayer exercised an incentive stock option for public company stock in the tax year 2000, when the stock was worth over $1 million. The taxpayer could not sell the stock during 2000 because the company's blackout period was in effect throughout the remainder of the tax year 2000. The stock became worthless in 2001, and the Tax Court held that the resulting capital loss could not be carried back as an alternative tax net operating loss to the tax year 2000 to offset the income from the options exercise.
The United States Court of Appeals for the Fifth Circuit affirmed the Tax Court, holding that the taxpayer's stock was not subject to a substantial risk of forfeiture in 2000 despite the blackout, and that the taxpayer could not carry back the alternative tax net operating loss from the tax year 2001 to the tax year 2000. "The mere fact that a restriction prevented Merlo from transferring the shares during the blackout period was not enough to cause Merlo to forfeit the shares."
One benefit of non-qualified or non-statutory stock options is that the spread on exercise is not an alternative minimum tax adjustment. Sure, income and employment tax withholding is required upon exercise, and this can make exercise more difficult, but it certainly avoids the issue the taxpayer in Merlo confronted.
