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There’s a dark side to employee stock options under federal and state law, and it’s called the alternative minimum tax. Consider, as an example, the case of a network engineer at a Palo Alto, Calif., startup: He exercised his option to buy 25,000 shares of his company’s stock early this year when it was trading at $50 per share. By May, the stock had soared to $200 per share, placing the value of his holdings at $5 million. But his euphoria over being a multimillionaire was cut short when he learned that even if the stock’s worth plunged, he would have to pay the alternative minimum tax, or AMT, on the difference between what he spent to buy the shares and $1.25 million, the stock’s value at purchase. Unfortunately for the network engineer, by last week, the stock traded at $20. If he continues to hold the stock, now valued at $500,000, he’ll owe hundreds of thousands of dollars in taxes. As more and more employers grant stock options, experts say it’s increasingly important that employees protect themselves by learning about tax laws like AMT, particularly in a volatile stock market. “Holders of stock options have increased enormously, but wisdom on how to deal with the tax consequences hasn’t kept pace,” says Rick Schultz, CEO of OptionWealth, a financial planning site based in Rockville, Md. According to a new study by the National Association of Stock Purchase Plans, of all companies granting stock options, 44 percent offer them to every employee, up from 34 percent only two years ago. AOL Time Warner, for example, plans to offer options to each of its post-merger 85,000 employees. When the network engineer consulted a tax expert, he learned there’s a way to get around the tax law. According to Jerry Spector, a Silicon Valley certified public accountant, if the engineer sells all of the stock before year’s end, he can escape the AMT and pay taxes on the proceeds as ordinary income for a profit of about $280,000. It may not be the $5 million he saw on paper back in May, but at least he comes out ahead. “This is the dark side of options,” says Spector, whose clients have been calling him regularly as the end of the year comes into view and tax season approaches. “There are a lot of people out there who will be underwater unless they sell their stock by Dec. 29,” the last trading day of 2000. Because the market has plunged since March of this year, it’s likely that many stock-option holders could face large AMT consequences if they can’t sell by the last trading day of 2000. Because of company-enforced lockout-period restrictions and other limits, even experienced investors aren’t immune to the challenges of the complicated tax law. Gregory A. Bonfiglio, a partner at the Palo Alto office of Morrison & Foerster whose wife is an officer at Intel, realized the pitfalls of the AMT recently after the chipmaker’s stock fell sharply this year. “I’ve been in the market 10 years,” Bonfiglio says wryly. “But I was blindsided completely by the AMT.” To the couple’s dismay, they ended up having to pay several hundred thousands of dollars in taxes. To avoid getting caught by AMT, it’s best for all employees with stock options to have a pretax strategy, says Robert L. Sommers, a San Francisco tax attorney who specializes in e-commerce issues. He suggests two: The first strategy involves exercising options early, which some companies allow, permitting the worker to be taxed early, rather than waiting a year or more until the stock has actually vested. The second strategy calls for the option holder to wait until the stock seems to be at its highest price and then exercise all options and immediately sell the stock. “Either way,” Sommers says, “you’re not gambling your tax dollars in the stock market.” Copyright � 2000 The Industry Standard

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