Court Opinion

ID: 4336663
Source: CourtListenerOpinion
Date Created: 2018-11-14 02:57:15.462183+00
Date Added: 2024-06-11T14:47:35.629897
License: Public Domain

129 T.C. No. 4

               UNITED STATES TAX COURT

         EVAN AND CAROL MARCUS, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10679-05.              Filed August 15, 2007.

     In a series of transactions between 1998 and
2000, P exercised incentive stock options (ISOs),
acquiring 40,362 shares of V stock. In 2001, Ps sold
30,297 V shares for $1,688,875. Ps had a regular tax
basis in these shares equal to the exercise price,
$127,920. Ps had an adjusted alternative minimum tax
(AMT) basis in these shares equal to the exercise
price increased by the amount included in alternative
minimum taxable income (AMTI) by reason of the
exercise of the ISOs, $4,472,288.

      Ps argue that the difference between the adjusted
AMT basis and the regular tax basis of the V shares
sold is an adjustment under sec. 56(b)(3), I.R.C., and
therefore creates an alternative tax net operating
loss (ATNOL) under sec. 56(d), I.R.C. Ps argue that
the ATNOL may be carried back to reduce their AMTI in
2000.
                               -2-

          Held: The difference between the adjusted AMT
     basis and the regular tax basis of stock received
     through the exercise of an ISO is not a tax adjustment
     taken into account in the calculation of an ATNOL in
     the year the stock is sold.

     Don Paul Badgley and Brian G. Isaacson, for petitioners.

     Julie L. Payne, for respondent.

                              OPINION

     HAINES, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes of $491,829 and $178,664 for

the years 2000 and 2001 (years at issue), respectively.   After

concessions,1 the issue for decision is whether petitioners may

increase their 2001 alternative tax net operating loss (ATNOL) by

the difference between the adjusted alternative minimum tax (AMT)

basis and the regular tax basis of stock received through the

exercise of incentive stock options (ISOs) in 2000, but sold in

2001.

     1
      Respondent concedes that petitioners are not liable for
accuracy-related penalties under sec. 6662 for the years at
issue, and that petitioners’ 2001 capital gain will be reduced by
$58,244. Petitioners concede that they are required to report
additional capital gain of $15,147 for 2000.
                                  -3-

                            Background

     The parties submitted this case fully stipulated pursuant to

Rule 122.2   The parties’ first through fifth stipulations of

facts, along with the attached exhibits, are incorporated herein

by this reference.   Petitioners (husband and wife) resided in

Fairlawn, New Jersey, at the time the petition was filed.   All

references to petitioner in the singular are to petitioner Evan

Marcus.

     On October 14, 1996, petitioner began employment as Senior

Staff Systems Engineer at Veritas Software Corporation (Veritas).

He was employed by Veritas through 2001.   As part of his

compensation package, petitioner was granted several ISOs to

purchase Veritas common stock.3

     Petitioner exercised ISOs in transactions beginning November

18, 1998, and ending March 10, 2000, acquiring 40,362 shares of

Veritas common stock.   Petitioner paid $175,841 to exercise the

ISOs, acquiring shares with an aggregate fair market value of

$5,922,522 on the various dates of exercise.   Petitioners held

their Veritas shares for investment purposes and not as dealers

     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended. All Rule references are
to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated. Amounts are rounded to the nearest dollar.
     3
      During the years in question, Veritas shares underwent a
number of stock splits. All data set forth below reflect these
stock splits.
                                 -4-

or traders.   During 2001, petitioners sold 30,297 Veritas shares

acquired by the exercise of ISOs, for a total of $1,688,875.4

     Petitioners timely filed their 2000 Federal income tax

return.   On the return, petitioners reported regular taxable

income of $315,472, regular tax of $58,427, alternative minimum

taxable income (AMTI) of $5,990,714, AMT of $1,602,874, and total

tax of $1,661,301.    On March 6, 2003, petitioners filed their

first amended 2000 return, reporting regular taxable income of

$261,835, regular tax of $56,039, AMTI of $4,180,033, AMT of

$1,099,051 and total tax of $1,155,090.    Petitioners claimed a

refund of $506,451.    On May 12, 2003, respondent issued a check

to petitioners in the amount of $575,471, representing a refund

of 2000 income tax of $506,211 and interest thereon of $69,260.

     Petitioners timely filed their 2001 Federal income tax

return.   On the return, petitioners reported regular taxable

income of $467,505, regular tax of $105,600, AMTI of negative

$3,537,753, AMT of zero and total tax of zero.    On March 6, 2003,

petitioners filed with respondent their first amended 2001 income

tax return, reporting regular taxable income of $1,897,072,

regular tax of $414,212, AMTI of negative $2,249,867, AMT of

zero, and total tax of zero.

     4
      The options qualified for incentive stock option treatment
under secs. 421(a) and 423(a).
                                 -5-

     Petitioners attempted to file three other amended returns.

On April 15, 2003, petitioners submitted their second amended

2000 return, and second amended 2001 return, which were both

designated “Notice of protective/incomplete claim.”     Respondent

did not process these returns.   On January 26, 2004, petitioners

submitted their third amended 2000 return, which respondent did

not process.

     On March 14, 2005, respondent issued a notice of deficiency

to petitioners with respect to 2000 and 2001.    With respect to

2000, respondent denied petitioners’ claimed ATNOL deduction,

carried back from 2001, of $1,909,562, resulting in a deficiency

of $491,829.   With respect to 2001, respondent reduced

petitioners’ prior year minimum tax credit from $414,212 to

$213,748, resulting in a deficiency of $178,664.

                            Discussion

A.   The Alternative Minimum Tax and Incentive Stock Options

      Generally, a taxpayer is not required to recognize income

upon the grant or exercise of an ISO.    Sec. 421(a).   Although a

taxpayer generally defers tax liability resulting from the

exercise of ISOs until the taxpayer later sells the stock, the

taxpayer may nevertheless incur AMT liability.    Secs. 56(b)(3),

421(a).   This is because the AMT, a tax imposed in addition to

all other taxes, is determined with respect to a taxpayer’s AMTI,
                                  -6-

an income base broader than that applicable for regular tax

purposes.    Allen v. Commissioner, 118 T.C. 1, 5 (2002).

     AMTI is defined as the taxable income of a taxpayer

determined with adjustments provided in sections 56 and 58, and

increased by items of tax preference described in section 57.

Sec. 55(b)(2); Merlo v. Commissioner, 126 T.C. 205, 209 (2006),

affd.       F.3d      (5th Cir., July 17, 2007); Allen v.

Commissioner, supra at 5.     Pertinent to this case, for purposes

of computing a taxpayer’s AMTI, section 56(b)(3) provides that

section 421 shall not apply to the transfer of stock acquired

pursuant to the exercise of an ISO.     Therefore, the spread

between the exercise price and the fair market value of the stock

on the date of exercise is treated as an item of adjustment and

is included in AMTI.5    Sec 83(a); Tanner v. Commissioner, 117

T.C. 237, 242 (2001), affd. 65 Fed. Appx. 508 (5th Cir. 2003);

sec. 1.83-7(a), Income Tax Regs.

     As a result of these differing treatments, a taxpayer

subject to the AMT has two different bases in the shares of stock

he received upon exercising the ISO: a regular basis and an

adjusted AMT basis.     Merlo v. Commissioner, supra at 209; Spitz

v. Commissioner, T.C. Memo. 2006-168.     The taxpayer’s regular

basis is the exercise price.    See sec. 1012.   The adjusted AMT

     5
      If the taxpayer’s rights in the shares are subject to a
substantial risk of forfeiture or not transferable, income is not
recognized at the time of exercise. Sec. 83(a).
                                  -7-

basis is the exercise price increased by the amount of income

included in AMTI by reason of the exercise of ISOs.     Sec.

56(b)(3); Merlo v. Commissioner, supra at 209-210.

         With respect to the 30,297 Veritas shares sold in 2001,

petitioners had a regular tax basis of $127,920, the exercise

price.     Petitioners had an adjusted AMT basis of $4,472,288,

consisting of the $127,920 exercise price and $4,344,368 of gain

included in AMTI by reason of the exercise of the ISOs in the

year exercised.6

B.   Incentive Stock Options and the Alternative Tax Net
     Operating Loss

     Generally, a taxpayer may carry back a net operating loss

(NOL) to the 2 taxable years preceding the loss, then forward to

each of the 20 taxable years following the loss.     Sec.

172(b)(1)(A).     For AMT purposes, taxpayers take an ATNOL

deduction in lieu of an NOL deduction.     Sec. 56(a)(4).   An ATNOL

deduction is defined as “the net operating loss deduction

allowable for the taxable year under section 172,” subject to

exceptions and adjustments under section 56(d).     Sec. 56(d)(1).

The NOL deduction under section 172 is defined as “the excess of

     6
      Petitioners sold the 30,297 shares of Veritas stock for
$1,688,875. Therefore, petitioners realized regular tax capital
gain of $1,560,955 and an AMT capital loss of $2,783,413.
                                 -8-

the deductions allowed by this chapter over the gross income”, as

modified by section 172(d).7   Sec. 172(c).

     The ATNOL is then calculated by taking into account

adjustments to taxable income under sections 56 and 58, and

preference items under section 57.8    Sec. 56(d)(1)(B)(i), (2)(A);

Montgomery v. Commissioner, 127 T.C. 43, 65-66 (2006); Merlo v.

Commissioner, supra at 213.    Petitioners argue that the

difference between the adjusted AMT basis and the regular tax

basis of the Veritas shares sold in 2001, $4,344,368, is an

adjustment to their ATNOL under section 56(b)(3).9

     The applicable statutes do not provide for such an

adjustment.   Section 56(b)(3) provides in part:

     7
      Sec. 172(d) provides that in the case of a noncorporate
taxpayer, the amount deductible on account of capital losses
cannot exceed the amount includable on account of capital gains.
Sec. 172(d)(2)(A); Erfurth v. Commissioner, 77 T.C. 570, 576
(1981); sec. 1.172-3(a)(2), Income Tax Regs. As a result, excess
capital losses are excluded when computing an NOL under sec.
172(c). Montgomery v. Commissioner, 127 T.C. 43, 65-66 (2006);
Merlo v. Commissioner, 126 T.C. 205, 209 (2006), affd.     F.3d
    (5th Cir., July 17, 2007); Spitz v. Commissioner, T.C. Memo.
2006-168. Petitioners concede that their AMT capital loss
resulting from the sale of their Veritas shares is not included
in the calculation of an ATNOL.
     8
      Sec. 57 preference items are considered only to the extent
they increase the NOL for the year for regular tax purposes.
Sec. 56(d)(2)(A).
     9
      Absent an event causing an adjustment to the bases, such as
the death of the stockholder, see sec. 1014, the difference
between the bases will be the same as the amount of income
included in AMTI on account of the exercise of the ISO.
                                    -9-

            SEC. 56(b). Adjustments Applicable to
       Individuals.-- In determining the amount of the
       alternative minimum taxable income of any taxpayer
       (other than a corporation), the following treatment
       shall apply * * *:

                 *    *     *      *      *   *   *

                 (3) Treatment of Incentive Stock Options.--
            Section 421 shall not apply to the transfer of
            stock acquired pursuant to the exercise of an
            incentive stock option (as defined in section
            422). * * *

Section 421(a) provides in pertinent part:

            SEC. 421(a). Effect of Qualifying Transfer.-- If a
       share of stock is transferred to an individual in a transfer
       in respect of which the requirements of section 422(a) or
       423(a) are met--

                 (1) no income shall result at the time of the
       transfer of such share to the individual upon his
       exercise of the option with respect to such share;

       As stated above, under section 421(a), gain is not

recognized for regular tax purposes on the exercise of an option

that qualifies as an ISO.       Therefore, the only adjustment under

section 56(b)(3) is the recognition of gain for AMT purposes when

stock is transferred to an individual upon the exercise of an

ISO.    The adjustment is made in the year of exercise.    The

statutes do not provide for an adjustment in the year of sale.

       To support their position, petitioners cite Staff of the

Joint Committee on Taxation, General Explanation of the Tax

Reform Act of 1986, at 437 (J. Comm. Print 1987), which states:

       The structure for the alternative minimum tax on
       individuals generally is the same as under prior law,
       except that adjustments are made to reflect the fact
                             -10-

     that certain deferral preferences (such as accelerated
     depreciation) cannot be treated simply as add-ons if
     total income is to be computed properly over time. For
     such preferences, the minimum tax deduction may in some
     instances exceed the regular tax deduction (e.g. in the
     later years of an asset’s life), thus ensuring that
     basis will be fully recovered under both the regular
     and the minimum tax systems. * * * [Emphasis added; fn.
     ref. omitted.]

     Petitioners’ reliance is misplaced.   Basis recovery through

depreciation deductions for property used in a trade or business

or for production of income is not analogous to the recovery of

basis for stock, a nondepreciable capital asset.   Basis of stock

may be recovered under both the regular and the AMT systems, but

when that stock is sold at a loss, respect must be given to the

limitations on capital losses that are provided in sections 1211,

1212, and 172(d)(2).   These provisions are equally applicable to

the AMT as well as the regular tax system.   Montgomery v.

Commissioner, supra; Merlo v. Commissioner, supra; Spitz v.

Commissioner, T.C. Memo. 2006-168.

     We therefore hold that the difference between the adjusted

AMT basis and the regular tax basis of stock received by ISO is

not a tax adjustment taken into account in the calculation of an

ATNOL in the year the stock is sold.   Furthermore, the sale of

petitioners’ Veritas stock received through the exercise of ISOs

is a sale of a capital asset and thus does not create an ATNOL

due to the restrictions of section 172(d).   Merlo v.

Commissioner, supra.
                                 -11-

     In reaching our holdings, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.

     To reflect the foregoing,

                                             Decision will be

                                        entered under Rule 155.