AMT and massive dotcom debts

Great Debates
1

By now most of you are probably aware about one of the terrible consequences of the dotcom meltdown, workers that are suddenly out of a job…and saddled with enormous income taxes. I read of one man, Jeff Chou, whose entire net worth is about $700,000 short of his taxes due for 2000.

What happened was that a lot of these people got paid in company stock. Under the Alternative Minimum Tax law, any increases in the value of a stock given as compensation count as taxable income. This law was instituted to close a tax loophole; in the past, many of the extremely wealthy took most or all of their income in stock, since gains in stock don’t count as income until they’re realized (i.e. the stock is sold). This was intended as a tax on the wealthy only, since stock as compensation was almost exclusively an option for the wealthy back then. But now the law has saddled countless ordinary workers with debts they, unlike the richest Americans, can’t possibly repay.

Normally, the sensible thing to do would be to sell enough stock to cover the taxes. But the crash hit so fast that this stock became almost worthless well before April 15. I think it would have been asking a bit much of these people to sell months before the due date, especially with the economy flying high and absolutely no indication that the bottom would fall out almost overnight.

You know what, I believe that these people deserve some sort of relief. The spirit of the AMT was clearly violated, and everything so damn fast that no one, workers, employers, or government, can be blamed for not seeing the crash coming. I agree that it was foolish to throw so much money at a “new economy” that was little more than hype. But I’m not talking about investors who threw their money away on now-worthless stock, I’m talking about workers who threw months of their lives away and received now-worthless stock in lieu of money. They’ve been terribly wronged, and there’s nothing to gain by piling a second wrong (massive taxes) on top of the first. These people deserve something, dammit. A cap on the tax burden, at least. Let’s help out the good guys for a change.

Am I wrong? Hopelessly rose-colored glassed or Pollyannaized or whatever? Discuss.

2

I’m assuming the stock crashed after the new year, which means they had huge taxable income in 2000 and now no way to pay it.

I don’t think the government owes them anything. My view is that taking stock as compensation is extremely risky, and these people should have known that when they accepted that compensation choice.

It’s true that hindsight is 20/20, but I don’t think it’s the purpose of Government to help people who happen to get screwed by a bad economy.

I think the dude who is $700,000 short on his taxes oughta declare bankruptcy. At least some of his debt would then be forgiven.

3

DKW wrote:

cough capital loss deduction cough

4

I’m not sure you’re allowed to claim capital losses if you accept stock as compensation (since you didn’t buy the stock)

Any tax guys here?

5

friedo - For the record, he owes $2.5 million in income tax on a $6.5 million gain on his stock (never realized, of course). There’s no realistic chance that he’ll ever be able to pay it, so it looks like bankruptcy is in his future. As it almost certainly will be for many others.

I now know that accepting stock as salary is a risk (you’re taxed every time it goes up and don’t get anything back if it goes down before you sell). Nonetheless, I’ve never seen anything on this scale before, and, if nothing else, the government should take a good hard look at the AMT code and try to bring it up to date with the times. (There’s already been criticism that the AMT, unlike other income taxes, has never been adjusted for inflation.) There’s no need to burn down the store here, just rewrite what’s necessary to redirect the tax to whom it was intended for in the first place.

tracer - No dice, pal…learned that (in class, not IRL, thank goodness!) last week. If you receive stock as compensation, it’s not subject to capital gains or losses; it’s considered ordinary income. That’s exactly why the AMT was created, to prevent the mega-rich from using company stock to cheap out of income tax. Of course, at that time (1969), no one had any idea it would cause a crisis of this magnitude…

6

DKW: Are you saying that, if I exercise my Employee Incentive Stock Options, the basis value of the stock I purchase is equal to the strike price of the stock options, not the fair market value of the stock on the day the purchase was made?

7

People know the rules going in. I see nothing unfair about their situation. The simple fact is that they chose not to sell the stock the same day they exercised their options. At that point they took on the risk of the stock falling.

And the reason they took this risk is that they wanted to hold for at least a year to get the cheaper long-term capital gain tax rather than the more expensive short-term capital gain tax.

It surprises me how many people took incredible financial risks just trying to get a little bit richer. Well, maybe it should not surprise me.

8

What’s unfair is that you are being taxed on a purely paper gain. Not only that, but many people can’t sell the stock the same day due to company regulations. It seems unfair to me.

The risk people take on stocks should be losing their investment, or in the case of stock options, making their stock options worthless. Losing the worth of the stock options and having to pay taxes on imaginary gains seems to defy common sense.

9

avumede, maybe the rules should be changed, but these people knew the rules. if they could not sell the stock on the day they exercised options, they should have waited until the no-sell window closed before they sold them.

this isn’t rocket science. people with stock options can exercise at any time, whether the window is open or closed.
for me, i sell when the window is open (and really, it is onlyi closed for a few weeks per quarter), and sell the same day.

these people who are now in dire straits are the victims of their own greed. they exercised and held to get the 20% tax rate, rather than the 39% tax rate.

like i said, maybe the rules should be changed, but they KNEW they were taking a risk and got just a little bit too greedy.

anyway, they have generous bankrupcy laws to bail them out now. so the point is moot i guess.

10

zuma wrote:

Which is greedier:[ul][li]Holding onto the stock to get a lower capital-gains tax rate and thereby make a long-term investment in the company, or[/li][li]Turning around and selling the stock immediately, thereby taking a higher capital-gains tax rate and essentially engaging in a “take the money and run” practice that makes no long-term investment in the company?[/ul][/li]Long-term capital gains tax rates were made lower for a reason. The Federal government wanted to encourage long-term investing, because it’s better for the economy than short-term stock-price speculation.

11

For incentive stock options, you would be well advised to look up the AMT rules. If you exercise ISO shares to hold, yes, you are liable for AMT on the difference between the option price and share price on the exercise date, even if you aren’t selling the shares.

If you DO have to pay AMT, the share price at that time becomes your new cost basis when you eventually sell the shares (you have to declare an AMT adjustment). If you don’t, you pay on the difference from your option price when you realize the profit on selling the shares.

The people that are in a real bind right now, as others have indicated, are those that exercised, intending to hold the shares for a year to get taxed at capital gain rates instead of normal income, and the stock has since plummeted.

Note, that they would have been stuck raising money to pay AMT in any case. Had the dot-com shares stayed up, they would have probably had to sell a portion to cover their taxes.

It’s generally a good idea to avoid AMT liability. The AMT rules are complex, but as a rule of thumb, you can generally avoid AMT if you have 3 times as much income as the amount of gain subject to AMT. Turn that around, and you can figure out, given your salary and any shares you exercise and sell, how many ISO shares you can safely exercise and hold.

However, IANAA (accountant), so believe your tax advisor, not me.

Speaking as an engineer who has had and has a few options, I would suggest that a large part of the problem is a large class of people being given stock options and remaining astonishingly ignorant about how they operate. The more timid of these people who simply do a same-day-sale exercise at some point come out OK, though they cough up 39% of their profits. Some others are now finding out about the AMT rules the hard way.

12

yabob wrote:

So if the stock value were to plummet after they exercised, and they sold all the stock for, say, 1 cent per share, they would then have a capital loss equal to the fair-market value of the stock on the day they exercised minus 1 cent per share, right?

Is it possible to “carry back” the capital loss I just mentioned to the year when the AMT liability occurred, to offset it?

13

Let me also add that very few people are directly paid in stock rather than being issued options. Many, many people have taken drastically lowered salaries or no salaries in return for large options. Particularly in startups or pre-IPO’s. I’ve been there myself - I did my stint in a “garage” startup working my butt off at about 50-60% salary. Worked out. Would I do it again? I doubt it.

Most of the people I’ve heard of getting into this cleft stick are people that exercised options and held. A friend of mine at E.Piphany mentioned that a bunch of people over there are in exactly this bind. And there are dotcom related companies that have tanked far worse than that one, or completely turned belly up.

14

tracer - I don’t know. And I hope I NEVER have to find out. You would certainly have to actually sell the shares to realize the loss. My personal view is that I want to make sure I avoid AMT.

15

I, too, worked for a Silicon Valley start-up company (Geocast) that gave me big stock options. As with most start-up company’s stock options, these were Incentive Stock Options (ISOs) that vested over a period of 4 years. Geocast bit the dust a little less than two months ago, never having made it to IPO.

Fortunately, I never had to worry about AMT. I was lucky. Geocast was one of a handful of companies that offered its employees the ability to early exercise their stock options before they vested. Buying stock by exercising an unvested stock option results in the employee owning “restricted” shares of stock that he cannot sell and which the company has the option to buy back at the old exercise price if the employee quits or is terminated; these restrictions expire at exactly the same rate that the stock options would have vested. The advantage of this arrangement is that my exercise price was equal to the fair market value of the shares on the day I exercised, hence, no AMT, and the “long-term capital gains clock” starts ticking much earlier.

Unfortunately, that meant that the money I’d ponied up to early-exercise those Geocast stock options went down the tubes along with Geocast. I’m out $9375 for my troubles.

16

tracer - Again, I only recently found out about this, but to the best of my knowledge, stock options are covered under AMT because they’re part of a compensation package. Hence, capital gains/losses rules irrelevant. BTW, I was unaware that you got victimized by this crazy “new economy”, too. Sorry 'bout that. It should have dawned on you, though, that you lost a heap of money despite your precaution. That’s how bad the situation is.

If nothing else, the minimum that these honest workers deserve is to go through bankruptcy proceedings without harrassment or ridicule from those who were never in that situation. When a disaster strikes, you don’t spit on the survivors and berate them for being in the wrong place at the wrong time. I think a little restraint is in order here.

17

I wouldn’t really intend to berate anybody. The only point I wanted to make is that it behooves you to realize what it means to be given an option, and the kind of risks you are taking if you decide to exercise and hold.

Like I said, a lot of people never do anything but same-day-sale the things at some point, which avoids a lot of problems, though it’s just a big blob of regular income, and you’ll get whacked for taxes at 39% plus your state rate.

Getting to where any of this stuff is a possible problem IS very largely a crap shoot. In my case, I’ve had options in three companies, one of which went IPO, The other two were acquired before IPO and my options became options for shares in established companies.

That latter case is often quite lucrative, though you’ll probably have to hold your nose while the acquiring company screws up, rapes, cannabilizes and just generally wrecks your product and your organization. If you intended to get acquired from day one, and were conciously just trying to produce something the big guys would want, it probably works better. If I were going to do a startup, I think this is how I’d actually plan it - let’s find a niche that somebody like Oracle will want the play in but won’t commit the resources to do themselves, get an initial beta which proves the concept and gets the valuation up, and sell it. Trouble is, the VC guys don’t want to hear that, and want to see a roadmap to an eventual IPO.

18

I believe that you cannot discharge your tax liability through bankruptcy. That is why this is such a large issue. Not only are these people liable for the taxes, they are incurring penalties, none of which are forgivable at this time, unless the law is changed.

I don’t see how you can be assessed taxes on non-existant property. This law makes no sense.

19

I think there are two questions here: Is this a valid law…and should we bail out people that lost money do to this law.

I don’t know enough of the ins and outs to comment on the laws validity.

But I do know that doing anything involving the stock market is a risky deal. This is especially true when you bring dotcom riches into the works.

Who honestly didn’t see the dotcom meltdown? It was simply a matter of when.

Working for stock options is gambling…with pretty hefty stakes. I think that paying people largely with stock options is a pretty shaky business practice as is. But thats a game that some people chose to play. Nobody forced them at gunpoint to take stock options. The rules were laid out ahead of time and they decided to take the chance.

I don’t know how sorry I can feel for someone that took a stupid risk and got called on it.

20

even sven wrote:

Pundits of doom have predicted, oh, around 300 of the last 5 stock market crashes.