Tax Advice from the Dot Com Bubble; Beware of ISOs

Is another dot com bubble abrewin’?  Perhaps not.  But for some, the financial news lately may feel like somewhat of a time warp.  Reading about the stock market (particularly the tech market), one sometimes feels a touch of the 1990s.  Our AOL accounts may be long gone.  But a new generation of companies, like Facebook, are generating excitement that is eerily dot com-esq.

In case you are hoping to be the next Instragram (or even if not), I have some valuable tax advice for you.  Beware of incentive stock options.

Incentive stock options (“ISOs”) can be a great deal for employees.  Workers use them to buy their company’s stock at a discount; often a steep one.  The discounts can lead to big profits.  But they can also lead to big tax trouble.

During the dot com heydays, folks were going ga ga over ISOs, using them to buy their company’s stock on the cheap.  When prices were flying high, it was a gravy train.  But then the market crashed.  The stocks lost most (if not all) of their value.  This roller coaster ride erased many a short-lived fortune.  More lastingly, it had really nasty tax consequences.

Due to complex rules, some owed large tax bills as a result.  Bills they had no way to pay off.  They were trapped.

The culprit was a thing called the Alternative Minimum Tax (“AMT”).  The AMT is a complex set of rules that even tax practitioners have a hard time understanding.  In essence, it works like this:

An employee buys $500,000 worth of stock, paying the bargain basement price of $10,000.  For AMT purposes, the person has just received $490,000 of taxable income (the discount between what they paid and what they received).  The person files their taxes and has a large tax bill as a result.  Then the market drops.  The stock becomes worthless.  The key here is that the stock losses do not offset the earlier tax gain.  The person is stuck with a large bill even though they have nothing to show for it.  And unless plenty of other savings are on hand, the person may have no way to pay the bill.

During the dot com hangover, the above scenario played out for a number of unfortunate victims, many of whom began living in a tax nightmare.  According to ReformAMT, an advocacy group, a number of them lost their homes and retirement savings, filed for bankruptcy, left the country, got divorced, even committed suicide.

Recently, I spoke with Jeff Chou, a spokesperson for ReformAMT.  Mr. Chou recalls those dot com days vividly.  He also recalls the group’s tough slog through Congress in search of relief.  Mr. Chou hopes that history will not repeat itself.  But he sees many eerie parallels with the hot tech market today.

Because of the advocacy work done by ReformAMT, a bill was ultimately passed to provide tax relief for persons in this situation.  But importantly, that relief is temporary and will disappear soon.

Could a new episode of AMT distress be in the making?  Mr. Chou hopes not.  But tellingly, he says that his phone has recently begun ringing again, with fresh calls from new victims.  Taxpayer beware.

Douglas Greenberg