7551 / How are stock options treated for alternative minimum tax purposes?

For purposes of the alternative minimum tax, the excess of the fair market value of the stock on the date of exercise of the option over the exercise price will be added to alternative minimum taxable income in the year the option is exercised, provided the taxpayer’s rights are not subject to a substantial risk of forfeiture. But if the taxpayer is subject to the alternative minimum tax, the basis in the stock for alternative minimum tax purposes will be increased by the amount included in income.¹ A taxpayer with unvested stock may wish to make a special election under IRC Section 83(b) to include in gross income for the taxable year an amount equal to the excess of the fair market value of the property at the time it was transferred over the amount (if any) paid for such property. By making the special election, the adjustment for AMT purposes will be reported in the year the election is made instead of the year the stock actually vests. This may be beneficial if the stock price is expected to significantly appreciate before the stock vests.

The Service has stated that for tax years in which a taxpayer is liable for both incentive stock option AMT and non-incentive stock option AMT, it would apply the taxpayer’s payments first to the non-incentive stock option liabilities and related interest and penalties (if any).²

2008 legislative relief for incentive stock options. As noted above, under the AMT a taxpayer must pay tax on the stock value when the option is exercised. The economic downturn in 2000 resulted in many individuals having to pay tax on “phantom income” because the stock prices dropped dramatically after the date of exercise. Congress provided relief for these situations in 2006, but recognized that additional relief was still needed to correct this problem. The Tax Extenders and Alternative Minimum Tax Relief Act of 2008 addressed problems concerning the treatment of certain underpayments, interest, and penalties attributable to the treatment of incentive stock options. The Act provided relief by (1) abating any underpayment of tax outstanding on the date of enactment related to incentive stock options and the AMT, including interest; (2) eliminating the income phase-out; and (3) extending and modifying the AMT credit allowance against incentive stock options. This relief provision has since been repealed.³ For details, see Q 777.⁴