If you exercised incentive stock options (ISO) in the last several years, you may have been hit with a hefty alternative minimum tax (AMT) bill. The AMT is charged when you exercise your ISO and hold on to your shares and sell them after the calendar year in which they were awarded to you. The AMT is calculated based on the difference between the fair market value (FMV) of the shares on the date that you exercised the shares and the exercise price. (Learn more about the AMT, read Cut Your Alternative Minimum Tax.)
While no one is happy about paying tax on a stock transaction, there is a tax law provision – called the AMT credit – that benefits taxpayers. When you pay your AMT bill, that AMT credit is automatically triggered. That credit can be used to lower your federal income tax bill when the amount you owe on taxes is more than what it would have been under the AMT. That's because, unlike a deduction that lowers the total amount of income on which you are taxed, a credit actually lowers your tax bill dollar-for-dollar. The provision is a way that Congress helps offset the taxes stockholders incurred for exercising their ISOs.
However, many investor-taxpayers found that the AMT credit did not significantly lower their federal income tax bill. And so Congress instituted tax law changes in 2007, and then amended them again in 2008, to increase the benefits of taxpayer's unused AMT credits by making them "refundable."
How It Works
The new tax law changes that took effect in 2007 were designed to further help people who exercised their ISOs and had to pay the AMT. Congress passed changes that were to go into effect between 2007-2012. Those changes now deem unused AMT credits that are at least three years old (sometimes referred to as "long-term unused AMT credits") as "refundable" by the Internal Revenue Service (IRS). That means that you can claim those credits to:
- reduce your current AMT bill.
- lower your current federal income tax bill dollar-for-dollar.
- carry qualified refundable credits over indefinitely (applying them to subsequent income tax bills).
- collect leftover credits as a cash payment from the IRS
The law that went into effect in 2007 (for taxes paid in 2007 on 2006 earned income) permitted people to claim the greater amount of either 20% of their long-term unused AMT credit or $5,000. However, the IRS also put income limits in place to reduce the amount of credit that higher-income earners could claim.
Congress amended the law for 2008 by eliminating the income limits and increasing the amount considered refundable.
Calculating Your AMT Credit
If you have exercised ISOs in the past, you can calculate your potential refundable AMT credit by using the 1040 Form worksheet for Form 6251 (line 45), talking to a tax filing professional, consulting with an accountant or using the IRS's online AMT Assistant.
Changes implemented in 2008 do not limit your credit to the total amount of income tax you owe, meaning that you can claim AMT credits that total more than the amount of money you had withheld for taxes, already paid in quarterly estimated tax or that you owe on your current tax bill.
Effective 2008 (for taxes paid in 2009 on 2008 earned income), people can claim the greater amount on:
- 50% of long-term unused credit accumulated three years or more prior to filing year
- the amount of refundable AMT credit listed on last year's 1040 form
For example, if you had earned $80,000 in AMT credit in 2004 and none in subsequent years, you could claim $40,000 (50% of the qualified unused credit) when filing your 2010 taxes in April, 2011. To collect your refundable credit of $40,000, you will need to complete IRS Form 8801 and send that in to the IRS along with your 1040 Form.
However, let's say that you owe $11,425 in federal income taxes for filing year 2009. When the IRS receives your Form 8801 (to claim your refundable credit of $40,000) it will first deduct the amount you owe ($11,425) and then mail you a check for the difference of $28,575.
So far, so good – you've been able to use the refundable credit to pay your federal income tax bill and receive a cash refund. But the good news doesn't end there. In 2011 you will be able to claim $40,000 in refundable credit - the balance remaining from the 2008 refundable credit amount. You can collect that remaining credit when you submit your Form 1040 for your 2010 taxes.
While the refundable AMT credit provision is only scheduled to exist for six years (2007-2012), Congress has the ability to extend the provision or make it permanent.
If you have paid an AMT bill on ISOs that you exercised, be sure to take advantage of the refundable AMT credit provision. It can go a long way in helping you pay your AMT bill, recoup money you paid out on your AMT bill and pay your federal income tax bills. If you have long-term unused credit from multiple AMT bills paid three or more years ago, you may want to work with a professional tax preparer or tax attorney to ensure that you're correctly filing your claims and maximizing your benefits. (If tax rules are confusing to you, take a look at Making Sense Of The Tax Code to find ways to help you understand it.)
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