Probate & Trust Law Section Conference Manual ... - Minnesota CLE

The Well-Prepared Executive: Personal Wealth Preservation Strategies
income. The taxable income is then adjusted
upwards and downwards for the AMT adjustments
such as the ISO adjustment and the AMT exemption
amount to arrive at alternative minimum taxable
income (“AMTI”). AMTI is then multiplied by the
AMT rate. If the resulting amount exceeds the
taxpayer’s regular tax liability, the excess amount is
the taxpayer’s AMT.
b. AMT Credit
In general, taxpayers can carry forward the
AMT as a credit to offset future regular tax liability.
IRC § 53(a). Thus, the AMT is in effect a
prepayment of the executive’s future regular tax
liability.
c. Avoiding the AMT Issue: ISOs
Immediately
Exercisable.
ISOs have historically been granted where
the exercise is subject to a vesting schedule. If the
value of the stock is higher at the time of exercise
(which presumably will always be the case or else
the executive would not exercise), the executive
may have a large AMT liability upon exercise. This
result can be avoided by granting the executive ISOs
that are immediately exercisable into stock that is
subject to a vesting schedule. The executive can
then choose to immediately exercise the ISO and
make an IRC § 83(b) election to include the value of
the ISO stock into income for AMT purposes at the
time of exercise. Because the ISO exercise price
must equal the fair market value of the ISO stock on
the grant date, the executive should have no AMT
upon the immediate exercise of the ISO. Another
benefit of granting ISOs that are immediately
exercisable is that the executive’s holding period
starts to immediately run. This same strategy works
for NQOs with a fair market value exercise price.
The ability to grant immediately exercisable ISOs
may be limited by the $100,000 per year limitation
discussed below. A disadvantage of immediately
exercising an ISO is that the executive must pay the
exercise price and therefore lose the benefit of not
having to risk his capital and being able to invest
those funds in other investments.
d. Minimizing AMT by Periodic ISO
Exercises
Whether a taxpayer is subject to AMT
depends on several factors, including the number of
AMT adjustments, the taxpayer’s regular tax rate,
and the AMT exemption amount. The only way to
determine the AMT exposure is to simply “run the
numbers.” One ISO planning strategy is to exercise
just enough ISOs during each year to not be subject
to AMT. By doing so, the ISOs exercised are not
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subject to the AMT and the holding period begins to
run on the underlying ISO stock. In deciding
whether to employ this strategy, taxpayer’s must
consider the disadvantage of having to pay the ISO
exercise price and therefore lose the benefit of not
having to risk his capital and the ability to invest
such funds in other investments.
e. Equalizing Regular Tax and AMT Liability.
A taxpayer who is subject to AMT should
consider increasing his regular tax liability to equal
his AMT liability. For example, a taxpayer with
ISOs and NQOs could exercise enough NQOs to
equalize the regular tax and AMT liabilities. This
strategy results in the taxpayer exercising NQOs
without having to pay any additional current tax
liability.
f. Drop in Stock Price: Exercising Before
Year-End.
If the stock value falls, the taxpayer who
previously exercised ISOs will now own the stock
with a much lower value. The AMT liability
triggered from the prior ISO exercise may even be
more than the current value of the stock. For those
taxpayers who exercise ISOs for stock that has
declined in value, their AMT liability can be
minimized by selling the stock before the end of the
year. Under IRC § 56(b)(3), the AMT liability is
based on the lower sales price if the ISO stock is
sold in the same year that the ISO was exercised.
For those taxpayers who exercised ISOs in earlier
years and now face an insurmountable AMT
liability, they should consider negotiating an Offer
in Compromise or Installment Plan with the IRS.
While there have been some legislative proposals to
retroactively change the AMT rules for ISOs, it does
not appear that this proposed legislation will pass.
5. ISO Requirements
ISOs must meet each of the statutory
requirements set forth in IRC § 422. Failure to
satisfy any requirement will result in the ISO being
treated as an NQO.
a. Employees of Granting Corporation or
Affiliated
Corporation.
ISOs can be granted only to employees of
the corporation granting the ISOs or a parent or
subsidiary corporation of the granting corporation.
IRC § 422(a)(2).
(1) Employees Only
ISOs may be granted only to employees.
Whether an individual is an employee is determined
under the withholding tax rules of IRC § 3401(c),