Difference Between Adjusted AMT Basis and Regular Tax Basis of Stock Received by an Incentive Stock Option (ISO) Is Not an Adjustment in Calculating an Alternative Tax Net Operating Loss (ATNOL) (Marcus v. Commissioner)
Community Bank Advisor , 2007 Fall

Mr. Marcus, as part of his compensation package, was granted an ISO to purchase 10,000 shares of company stock at an exercise price of $10. When Mr. Marcus exercised the ISO in early 2004, the fair market value (FMV) of the stock was at $200. When he later sold the stock in late 2005 (after meeting holding period requirements for long-term capital gain treatment) the FMV was $20 per share.

What does this mean for tax purposes?

The AMT and ISOs

For regular tax purposes, you generally aren’t required to recognize income upon grant or exercise of an ISO. The tax is deferred until the stock is sold.

For AMT purposes, an adjustment is required upon exercise for the difference between the exercise price and the FMV at exercise date. This means that a taxpayer subject to AMT will have two different bases in the ISO stock.

It also means Mr. Marcus paid a lot of AMT in 2004. When he exercised his options he had an AMT adjustment of $1,900,000. When the stock crashed in 2005 and he sold the stock for $200,000, he recognized a modest gain of $100,000 for regular tax purposes but a large $1,800,000 loss for AMT purposes. Mr. Marcus incorrectly thought his $1,800,000 AMT loss in 2005 created an ATNOL that he could carry back to 2004 to get his tax refunded.

Court’s Conclusion

The difference between the AMT basis and the regular tax basis of stock acquired through an ISO is not a tax adjustment taken into account in the calculation of an ATNOL in the year the stock is sold. The sale of stock received through an ISO is a sale of a capital asset, and the statutory limitations on capital losses that are equally applicable to AMT and regular tax must be followed (no carrybacks; $3,000 per-year loss limit).

Poor Mr. Marcus is stuck with a $3,000 capital loss limitation and a large AMT credit carryforward.