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, 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.
One thing that is no longer available, however, is a benefit that investor-taxpayers got from 2007 to 2012, which made their unused AMT credits "refundable." This tax benefit was instituted in 2007 to help investor-taxpayers who found that the AMT credit did not significantly lower their federal income tax bill. Congress passed these tax law changes in 2007, and then amended them again in 2008. However, the refundable AMT credit was not extended at the end of 2012, so the 2012 tax year was the last time that taxpayers could take advantage of this benefit.
In case you are looking at back taxes, here is how it used to work.
Understanding Refundable AMT Tax Credits
The tax law changes that took effect in 2007 were designed to further help people who exercised their ISOs and had to pay the AMT. Those changes deemed unused AMT credits that were at least three years old (sometimes referred to as "long-term unused AMT credits") to be "refundable" by the Internal Revenue Service (IRS). That means that taxpayers could claim those credits to:
- reduce their current AMT bill.
- lower their 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 the AMT Credit
People who had exercised ISOs in the past, could calculate their 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 did not limit a taxpayer's credit to the total amount of income tax owed, meaning that he or she could claim AMT credits that totaled more than the amount of money that was withheld for taxes, already paid in quarterly estimated tax or that was owed on the current tax bill.
Effective 2008 (for taxes paid in 2009 on 2008 earned income), taxpayers could 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 they had earned $80,000 in AMT credit in 2004 and none in subsequent years, they could claim $40,000 (50% of the qualified unused credit) when filing their 2010 taxes in April, 2011. To collect their refundable credit of $40,000, they would have needed to complete IRS Form 8801 and have sent that to the IRS along with their 1040 Form.
However, let's say that you owed $11,425 in federal income taxes for filing year 2009. When the IRS received your Form 8801 (to claim your refundable credit of $40,000) it would have first deducted the amount you owed ($11,425) and then mailed you a check for the difference of $28,575.
The taxpayer would been able to use the refundable credit to pay his or her federal income tax bill and receive a cash refund. What's more, in 2011 he or she would have been able to claim $40,000 in refundable credit – the balance remaining from the 2008 refundable credit amount. The taxpayer could have collected that remaining credit when submitting the Form 1040 for 2010 taxes.
Unfortunately for taxpayers who could have continued to benefit, the refundable AMT credit provision was only scheduled to exist for six years (2007-2012) and Congress did not extend it or make it permanent.
The Bottom Line
For the six years from 2007 to 2012, the refundable AMT credit provision helped some taxpayers pay their AMT bill, recoup money they paid out on their AMT bill and pay their federal income tax bills. Going forward, 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 according to current laws. (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.)