Originally published on Forbes.com.
People will often remark of wealth that “You can’t take it with you” . That is probably the last frontier of the estate planning industry. I’m sure there are people working on it. There are some things though that you can’t even leave behind. Apparently AMT credit carryforwards are among them. At least that is the holding in the recent Tax Court decision in the case of Nadine L. Vichich.
What Is An AMT Credit?
Although the alternative minimum tax presents itself as an add-on to the regular income tax, it is actually an entire parallel system. It has a broader base and lower rates than the regular income tax. There are some things, like state income taxes, that you never get to deduct in figuring AMT. There are other things where under the AMT regime income is picked up sooner or deductions are deferred.
Someday those timing adjustments are apt to turn around. If you paid AMT because of them you will be able to take a credit against your regular tax when that happens. This is all figured on Form 8801 which tracks the unused credit from year to year.
The Adjustment That Might Never Turn Around
An AMT adjustment that tripped a lot of people up was the one that arose from exercising incentive stock options. If the option meets certain qualifications, there is not regular income recognized when it is exercised. If you like the stock as a long-term investment or at least want to hold it for the long-term capital gain period of a year, you will have to deal with AMT, because the ISO exclusion is an AMT adjustment.
At issue in this case, was a credit of $304,442 that belonged to Ms. Vichich’s late husband William. He had acquired the credit in 1998, well before they were married.
There are no details on how he ended up with the credit other than that it related to ISOs. So what I will give you now is a hypothetical explanation as to how somebody might have acquired such a credit. We’ll use my friend James. James is a CPA who had a career much like mine only spottier and crazier because he is more impulsive. For example, I have explained to James many times that you can’t tell managing partners they are acting like Hitler – especially when it is true.
James got caught up in the dotcom bubble. Only, of course, when it was going on we called it the “New Economy”. He became the CFO of Hotbubble.com and got lots of stock options. They vested in September 1998 and he purchased $1,300,000 worth of Hotbubble.com for $100,000.
James told me that he was going to hold the stock till September 1999. I reminded him that he was going to have to pay AMT in April. No problem. He can take out a margin loan to cover that. What could possibly go wrong? Well you and I both know that what could go wrong and what you might guess did go wrong is the price of Hotbubble.com collapsed in August. It collapsed so quickly that all James got for the stock was $50,000.
Here is the entertaining part. Come April of 2000, he was expecting he would get his $300,000 of AMT back since the transaction reversed and he was kind of shocked when he saw that he was not getting any of the credit. You see the AMT is an entire parallel system which incorporates all the regular tax rules except as they differ for AMT purposes. So that sale in August did not reduce his AMT income by $1,250,000. It reduced it by $3,000 just like his regular taxable income was reduced by $3,000. He ended up with a capital loss carryover for regular tax purposes of $47,000 and an AMT capital loss carryover of $1,247,000. To really get much use out of that $300,000 credit James would need to have some capital gains
Relief
Having much of Silicon Valley get a tax hosing was something that Congress was bound to get around to addressing eventually. The Tax Relief and Health[Care Act of 2006 allowed unused AMT credits to be taken as refundable credits over two years. That was the relief that Ms. Vichich was seeking in 2008 and 2009 for a total of just over $300,000.
Only It Was Not Her Credit
It was William’s credit and he had died in 2004. In 1998 when the credit was “earned’, so to speak, he was married to somebody else. There was no issue made of the credit not being his after the divorce.
At the outset, we note that neither party has questioned the availability of the AMT credit to William Vichich following his divorce from Marla Vichich. Both respondent and petitioner proceed on the assumption that the AMT credit belonged wholly to William Vichich and that no part of it belonged to Marla Vichich, with whom he filed a joint return for 1998, the year in which he exercised ISOs that generated the AMT credit at issue. The issue of a tax benefit surviving a divorce is closely related to the issue of a tax benefit surviving the death of a spouse. In both cases, the marriage ceases to exist, and tax attributes reported on a joint return for an earlier year must be properly allocated for subsequent years to the divorced spouses or to the surviving spouse, as applicable.
The Tax Court ruled that Ms. Vichich was not entitled to the AMT credit that Mr. Vichich brought into the marriage. It compared the credit to among other things net operating losses.
While we recognize that the purposes of the AMT credit and the NOL carryover are not identical, we nonetheless find informative the authorities limiting the transfer of NOL carryovers between spouses. Petitioner offers us no reason not to extend those authorities to this case. She grounds her claim to the credit in issue entirely in the remedial purposes she alleges underlie section 53(e) and (f). Those subsections, however, have no bearing on her ability to take into account, for purposes of section 53(b)(1), the adjusted net minimum tax imposed on her husband before their marriage. Therefore, because petitioner could not deduct for a postmarital year an NOL incurred by her husband even during their marriage, much less before it, we conclude, on the basis of the record and the arguments before us, that, she was not entitled to take into account under section 53(b)(1) her husband’s premarital adjusted net minimum tax liability in computing her own minimum tax credit for tax year 2009.
Practical Observations
AICPA standards of tax practice forbid me to give advice based on the audit lottery, but you are not my client, so I will observe this. Ms. Vichich dropped the Form 8801 credit carryover from her returns after her husband died. Claiming them was a later inspiration. If the credits had been consistently carried forward, I suspect nobody would ever have been the wiser. That, of course, is not the way to run your life. Just saying.
The other practical observation from a planning viewpoint is to note many valuable tax attributes even for example basis in excess of value will die with the taxpayer. There may be planning opportunities that present themselves. Consider a taxpayer with large charitable carryovers or net operating losses and substantial IRA assets. It might be worth ending the income deferral while there are attributes to shelter it rather than leaving behind an income tax liability.
Other Coverage
Lew Taishoff covered the case with a post titled One Return, Separate Taxpayers. He observes:
I do want to give a Taishoff “Good Try, First Class” to Nadine’s counsel, Stephen L. Kadish, esq., and Matthew F. Kadish, esq. As the golfers say “Never up, never in.”
Good point. The IRS dropped the accuracy penalty before the Tax Court got to decide on it.