Vince Bowey never realized that stock options could nearly bankrupt his family. He left PriceWaterhouseCoopers in 1998 to join a customer service software start-up and took stock options as part of his incentive package.
Bowey knew that some of his hoped-for profits would be gobbled up by the alternative minimum tax, or AMT -- a complicated tax provision that can, among other things, trigger a 28 percent tax on the difference between an option price and the value of the stock the day of the purchase. In other words, Bowey -- whose options allowed him to buy 13,000 shares of his company's stock for $1 apiece at a time when the stock was trading at $75 -- was looking at an AMT tax bill of about $269,360, 28 percent of his "paper gain."
Bowey knew that by exercising his options but not selling his stocks he made himself vulnerable to the AMT, but he assumed that the eventual gains would outstrip the tax liability. Even if the stock dropped by half -- which seemed unlikely at the time -- he figured that he'd have more enough money to pay Uncle Sam.
Then the market nosedived and Bowey's tax bill became overwhelming. All told, Bowey and his wife, Christine -- a Navy officer who has served for 23 years -- owe more than $335,000 in taxes, one and one-half times their combined income. Even if they sold all of Bowey's optioned shares, their tax bill would still outpace their ability to pay.
"It's ludicrous," Bowey says. "We have a huge American flag in our yard, I spent five years in the Army and my wife is still serving. We're very patriotic. And we don't live high on the hog. We're living check to check. But the AMT caught us."
The Boweys' situation is hardly unique. Stories of AMT woe began flooding the press a few weeks before taxes were due this year, and the tide continues. Thousands of people who bought into their own companies while the market was high spent most of April trying to figure out how on earth they would pay the government for gains they never realized. The AMT discussion forum teems with the outrage and fear of those who are taking out second mortgages on their homes, leveraging their 401K plans and surrendering their kids' college funds to the IRS.
These probably aren't the kinds of stories that the writers of the AMT tax envisioned. The tax was originally designed to affect only the very rich, but as companies handed out options not just to attract talent, but as a way of lessening their tax load over time, those affected by the AMT came to include much of the stockholding middle class. Increasingly, stock market newbies who had unquestioningly acquired stock options along with the free sodas and gym memberships of the tech boom have found themselves subject to a tax law they previously knew nothing about. The flip side of the AMT tax, the AMT credit, may eventually reimburse some of them, but for many it's too little, too late. Meanwhile the AMT tax has become a political wake-up call.
Bowey and dozens of other "AMT victims," as they're calling themselves, aren't taking the AMT in stride. They've decided to get organized.
Silicon Valley has found cause to get political before -- for H1B visas and vouchers, for example -- but the anti-AMT movement stands out. It's a movement of individual discontent, a sudden reaction to what's perceived as a government intrusion into personal finances. These victims aren't political professionals, they aren't holding meetings or launching ad campaigns -- tools familiar to the relatively wealthy and newly enfranchised. Instead, they're going grass-roots: writing earnest group e-mails to their members of Congress, sharing research and launching Web sites.
"It's like a second job," says Bowey, referring to his new political gusto. "But it's worth it. The tax is wrong."
The AMT was designed in 1986 to keep extremely wealthy individuals from avoiding income tax. Essentially, it's a parallel track of taxation that ignores certain deductions and treats more "income" as taxable. If the total dollar amount owed under the AMT is higher than what was calculated with traditional income tax, then people must pay the higher figure. Thanks to the AMT, taxpayers who've managed to knock their taxable income down to zero -- using various deductions and tax shelters -- don't get a free ride from the IRS.
Few qualified for the AMT at first; it worked as designed -- a tax trap for the very wealthy. But over the years, the law was never indexed for inflation, and gradually, more and more people found themselves subject to it. The dot-com boom only expanded the AMT's reach, and when options became the currency of the new economy (and as companies discovered that giving options to their employees allowed them to take a major tax break), the AMT became a more significant source of IRS revenue.
"It keeps creeping up from something that affected the very rich, to something that now affects upper-middle-class taxpayers," says Martin Schainbaum, a San Francisco tax attorney and former member of the California Bar Association's commission on tax specialization. "It takes a lot of young people -- who make just over $100,000 a year, with a house, car and say, $50,000 in the bank -- and puts them into tax servitude. They're paying for phantom gains with real money."
Reforming the AMT has had broad support across party lines: both Republicans and Democrats have proposed legislation to tame -- or demolish -- the AMT.
The Republican-sponsored bill aims to fix the problem by repealing the entire AMT. Introduced in the House by Deputy Whip Sam Johnson, R-Texas, H.R. 275 would maintain the AMT for corporations but not individuals. One might expect this kind of drastic repeal to win the hearts of those afflicted by the AMT tax on exercised options, but so far H.R. 275 hasn't enjoyed much attention in Silicon Valley.
It may be that stockholders there object not to the spirit of the AMT tax, but to this particular aspect of it. But it's also a matter of money. The more popular bill, H.R. 1487, sponsored by Rep. Zoe Lofgren, D-Calif., offers a narrower reform -- it simply removes stock options from the AMT. But it contains one particularly alluring provision: It would be retroactive. If it passed, the IRS would be forced to pay refunds to those who paid AMT tax on their options.
That's only fair, says Sheryl Johnson, a single 33-year-old who owes about $250,000 in AMT taxes. The law needs to be changed, she argues, because far too many people were ignorant about the threat the AMT could pose and, consequently, got hit with an obscure tax that they hadn't been properly advised to avoid. Johnson considers herself a prime example. She was aware of the AMT before she exercised her options and even hired a financial consultant to help her plan for it. But Johnson was advised to exercise her options, and so she did, unaware of the havoc it would wreak on her finances.
Her Achilles' heel was her company's employee shareholder policy. Whereas most people paying AMT tax could have sold their stock to make some money back, about half of Johnson's shares were locked up until after the tax bill was due.
Some of the blame belongs with the market: Had the boom continued, Johnson, Bowey and others would have simply sold at least some of their shares to pay the piper, and the AMT would have remained an expensive but not devastating tax nuisance. But Johnson argues that the AMT penalizes those it should protect -- the middle class who do not know much about the vagaries of tax law.
"I worry that a lot of people don't know that the Lofgren bill exists," she says. "They don't know that there's a solution."
Sheryl Johnson aims to publicize the Lofgren bill, and plans to launch a Web site and possibly a nonprofit organization to support it. Vince Bowey and other AMT "victims" from Cisco Systems and other companies have already launched ReformAMT.org, a Web site that aims to be ground zero for political action on the issue. The site looks simple now, but Bowey says they're planning to add links to everything from a breakdown of how the law works to comments from personal-finance experts. They're also going to launch a letter-writing campaign, and aim to lobby CEOs for their support.
"John," a 35-year-old Silicon Valley tech worker who asked not to be named, also supports the bill. He was one of the first 10 people to join a company that now employs 1,500. As such, he began the tech boom with options to buy 300,000 shares of his company's stock at about $2 a share. This made for an enormous paper gain when John exercised his shares, at $75 and then at $40 -- but when he held on to his stocks and watched the share price plunge to $10, the paper profit became an AMT tax liability of well over $1 million.
John has chosen to pay a portion of his AMT tax and file an extension, hoping the market recovers or the new bill gets passed. But while his finances hang in the balance, and with the market showing few signs of recovery, John faces the prospect of having to essentially surrender the earnings from his stocks -- his reward for having joined the right company at the right time. "If the stock doesn't go up again, the net effect is that I gave 85 percent of everything I've made over the seven years of working for this company to the IRS."
But how much protection should people like John -- those who fit into the high-income demographic that the AMT was designed for -- enjoy from taxation? Critics argue those who, like John, were well advised of the risks of holding exercised stock options, understood the gamble and took it anyway. In that light, John's current tack -- filing for extensions while he waits for the market to rise -- is just another example of the delicate two-step that goes on between the wealthy and the IRS every April.
"The law isn't as cruel as it seems," says John McNulty, a tax law professor at UC-Berkeley. "The person paying may feel terrible for having to pay taxes for gains that they don't think they saw. And I feel sympathy for them. But they did make a profit when they exercised the option. It's counterintuitive, it's a different approach. But where the property is easy to value, and when you're trying to check on what people are really making -- which is what the AMT tries to do -- then taxing stock options is fair. Any time we don't make the AMT as broad as possible, or we cut it back, we are undermining the principal purpose of it."
Many AMT proponents also cite the AMT credit as proof that the tax is part of a larger and rational tax system. The credit is at least as complicated as the tax: The way it works is that those who've had to pay AMT tax in one year are allowed, the following year, to claim a certain amount of "credit" from last year's AMT tax. The amount varies according to the details of the individual AMT filing, but for some, it can go a long way toward compensating for last year's tax burden.
A handful of unpopular posters on the AMT discussion forum maintain that AMT victims should stop complaining and pay up what's an essentially fair tax. After all, argues one poster, the options are essentially a taxable gift given to you by your employer -- like a car awarded to the employee of the year. And as such, you pay taxes on the gift's value at the time of receipt -- "even if you fail to get insurance on it and it's stolen the next day."
But the AMT opponents make a similar appeal to intuition. Why tax people on earnings that they never actually had? The AMT tax, says CPA Tony Pimentel, "violates the green paper rule. You only assess taxes based on the person's ability to pay. Otherwise you force people to go underground. Then they become nonproductive."
Tax debts -- like credit card debts -- prevent Americans from living up to the label economists have always given them: consumers. If consumer spending is the hallmark of a healthy economy, then debt-saddled Americans are dragging the economy down. So why, argue anti-AMT lobbyists, should the IRS tax away the spending money of some of its most vital consumers?
Bowey stresses that the law no longer fits economic reality. The AMT remains mired in the 1980s, he argues. It treats stock options as shelters for the super-rich, failing to acknowledge the democratization of the markets, the fact that almost half the country owns some form of stock. As long as companies find it advantageous to offer so many stock options, and until government and the public alters their view of them, he says, the activism will continue.
"There is a perception that everyone with options are whining dot-commers with Ferraris," he says. "But that's probably one out of 50,000 cases. I don't think we're being greedy. We live paycheck to paycheck. I'm just looking for what's fair. We've paid more than our fair share of dues."
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