AMT on Stock Options That Lost Value: Payment Plans and Credits

Why do I owe tax on stock options that lost value?

The tax on an option exercise is generally set by the shares' value when you exercised, and a later drop does not reopen it. For ISOs, the spread between that value and the exercise price is an AMT adjustment on Form 6251, line 2i, in the exercise year (IRS). For NSOs, the spread is wage income in the exercise year (Publication 525). The fall in price shows up later, as a credit or a capital loss, not as a smaller bill now.

There are three ways out, in this order:

A case is not simple when the shares cannot be sold, when the balance is above the online payment plan limits, when you also owe state AMT, or when you exercised over several years. Gather Form 3921 for each ISO exercise, your W-2s, every Form 6251 and Form 8801 you have filed, any IRS notice, and records of what you paid and when.

How the AMT itself is figured is in AMT on incentive stock options.

If it is still the exercise year, does selling the ISO shares cut the tax?

Yes, usually. If you exercise ISOs and sell the shares in the same year, regular tax and AMT treat the shares the same way and no AMT adjustment is required (Form 6251 instructions).

The sale is a disqualifying disposition, so the regular-tax result changes too:

• Sold above the exercise price but below the value at exercise: ordinary income is limited to the gain on the sale, not the full spread at exercise (26 CFR 1.422-1(b)(2)).
• Sold below the exercise price: there is no ordinary income, only a capital loss (Publication 525).
• Sold above the value at exercise: the full spread is ordinary income and the rest is capital gain.

The cap on ordinary income does not apply if a loss on the sale would not be allowed, for example a wash sale where you buy the same stock back within the wash-sale window, a sale to a related person, or a gift (26 CFR 1.422-1(b)(2)(ii)). Private-company shares often cannot be sold at all; a tender offer may be the only window.

What should I file and pay first if I can't pay it all?

File the return on time even if you cannot pay. The penalty for filing late is 5% of the unpaid tax per month, up to 25%, while the penalty for paying late is 0.5% per month (IRS; IRS). An extension gives more time to file, not to pay (IRS).

1. File the return with Form 6251 by the April due date, or an extension by then. From the next year on, add Form 8801.
2. Pay as much as you can by the due date. Interest runs on what is left.
3. Request a payment plan for the rest (below).
4. Stay current on this year's tax. A payment plan can default if later returns or taxes are not filed and paid on time (IRS). Estimated payments for an exercise this year are covered in AMT on incentive stock options.
5. Answer every IRS notice by its date, even while a plan is pending.

Can I get an IRS payment plan for an AMT or stock option tax bill?

Yes. Individuals can pay over up to 180 days with a short-term plan, or monthly with a long-term plan (installment agreement) (IRS).

Low-income taxpayers pay a reduced fee or none. Above the online limits, you can still apply with Form 9465 and, where its instructions require, Form 433-F (IRS).

A payment plan does not stop the cost:

• Interest compounds daily at a rate the IRS resets each quarter; it is 7% for the current quarter (IRS).
• The late-payment penalty drops to 0.25% per month during an approved plan, but only if you filed the return on time (IRS).
• Refunds in later years are applied to the balance until it is paid (IRS).

The IRS generally will not levy while a plan request is pending or a plan is in effect (26 U.S.C. 6331(k)), but unpaid tax can lead to a federal tax lien.

Can I settle the tax bill for less than I owe?

Only if you cannot pay. An offer in compromise may settle a tax debt for less when paying in full is not possible or would cause financial hardship; the IRS weighs your current income, expenses and asset equity, and generally will not accept an offer if the debt can be paid through a payment plan or your assets (IRS).

To apply you must have filed all required returns, made required estimated payments and not be in an open bankruptcy. Each application needs a $205 fee and a first payment, such as 20% of the offer for a lump-sum offer, unless you meet the low-income rules. A rejected offer keeps the fee and applies the payments to your balance. A large bill from a past exercise does not by itself qualify; the test is ability to pay now.

How do I get the AMT back with the minimum tax credit (Form 8801)?

AMT caused by an ISO exercise generally comes back as a credit against regular tax in later years, figured on Form 8801. The credit covers AMT from deferral items, such as the ISO adjustment; it does not cover AMT caused by exclusion items, such as the standard deduction or certain itemized deductions (Form 8801 instructions).

• First year: the year after the AMT year. The credit is for prior-year minimum tax.
• Each year: file Form 8801 while you have a credit or a carryforward. It uses the prior year's Form 6251 figures, so keep every return.
• Unused credit: carries to the next year. The law has no end date for it; the credit is the total prior-year minimum tax not yet used (26 U.S.C. 53).
• Not refundable: the credit only reduces regular tax. It does not produce a refund on its own.

Why does the AMT credit carryforward come back so slowly?

The credit each year cannot exceed your regular tax, after certain other credits, minus your tentative minimum tax for that year (26 U.S.C. 53(c)). If the two are close, little credit is allowed, even when the carryforward is large.

The gap tends to widen in a year when you sell the ISO shares. The regular-tax gain is measured from the exercise price, but the AMT gain or loss is measured from the higher AMT basis, so the sale creates a negative adjustment on Form 6251, line 2k, which lowers tentative minimum tax (Form 6251 instructions). The AMT exemption and its phaseout also move the gap; see AMT on incentive stock options. State credits follow state rules.

What loss do I get when I sell, and how much can I deduct each year?

When you sell ISO shares after the exercise year, you have two results. For regular tax, gain or loss is measured from what you paid. For AMT, it is measured from your AMT basis: what you paid plus the AMT adjustment (Form 6251 instructions). Keep both sets of records. A sale within one year of exercise or two years of grant is a disqualifying disposition: for regular tax, any gain up to the spread is ordinary income in the sale year, while for AMT the same sale can be a capital loss (Form 6251 instructions).

A net capital loss first offsets capital gains, then up to $3,000 a year of other income ($1,500 if married filing separately); the rest carries forward until used (Publication 550). The same yearly limit applies separately to the AMT loss, so the AMT capital loss carryover can differ from the regular one (Form 6251 instructions).

Shares that become completely worthless are treated as sold on the last day of that tax year (Publication 550). If the company failed, see deducting shares in a failed startup.

I had NSOs and paid tax through payroll: can any of it come back?

The wage income does not come back. The spread at exercise stays income for the exercise year, along with the tax withheld on it. What you get instead is a higher basis: what you paid plus the income already taxed. A later sale below that basis is a capital loss, limited as above (Publication 525).

For options granted from 2014 on, the basis on Form 1099-B does not include the income already taxed, so the sale must be adjusted on Form 8949 or the same income is taxed twice (Publication 525). How to report it is in exercising startup stock options.

Example

These examples are illustrative; figures are in US dollars.

AMT from last year, shares down 80% this year

An employee's exercise-year return shows $50,000 of AMT, all of it from the ISO adjustment. By the due date the shares are down 80% and cannot be sold. The same-year sale is no longer possible.

1. Due date: files on time and pays $5,000. The rest, with penalties and interest, is under $50,000 when the plan is requested, so it can be requested online.
2. Return for the following year: files Form 8801. Regular tax exceeds tentative minimum tax by $6,000, so $6,000 of credit is used; the rest carries forward.
3. Year the shares are sold: the AMT loss from the higher AMT basis lowers tentative minimum tax, which can allow more credit that year. The regular-tax loss, if any, is deducted under the yearly limit.

ISOs exercised in March, value falls by November

An employee pays $20,000 in March to exercise ISOs worth $220,000: a $200,000 AMT adjustment if the shares are held past December 31. By November the shares are worth $70,000. Selling them to an unrelated buyer for $70,000 before December 31 removes the AMT adjustment, and ordinary income is $50,000 (the actual gain), not $200,000.

NSO spread taxed as wages, company now worthless

An employee paid $10,000 to exercise NSOs and had a $90,000 spread on a W-2. Two years later the company is worthless. The $90,000 of wages and its tax stay. The basis is $100,000, which becomes a long-term capital loss treated as arising on the last day of the worthless year, used against capital gains and then $3,000 a year of other income, unless part qualifies as a section 1244 ordinary loss; see deducting shares in a failed startup.

Different for you?

• You have not exercised yet, or you are deciding how much to exercise: see AMT on incentive stock options.
• You are leaving the company and the exercise window is closing: see exercising stock options when you leave a startup.
• The company has failed or the shares are worthless: see deducting shares in a failed startup.
• A tender offer lets you sell: see selling startup shares in a tender offer.
• Your balance is above the online plan limits, you exercised across several years, or past Forms 6251 and 8801 may be wrong: these need the returns reviewed together; get individual tax help.