Tax Nightmare

How tax aimed at rich trapped Catonsville couple

March 18, 2007|By Jay Hancock | Jay Hancock,Sun Columnist

Rita and Arthur Miller used to believe that honesty, hard work and filing taxes on time would keep you on society's good side.

They believed this until about 2001, when, in the parallel universe known as the alternative minimum tax, the government began seeking more than $100,000 in tax on income that the couple never received.

Six years later, the amount has doubled, and the couple will probably have to liquidate their retirement savings and maybe sell their townhouse to pay the bill. In a little-noted epilogue to the dot-com boom of the 1990s, the Millers are among thousands of families that the Internal Revenue Service says owe tax on phantom stock-market riches.

Maybe more than anything else, their situation demonstrates the brutal unfairness of the alternative minimum tax, which Congress is considering reforming because it now hits far beyond the super-rich it originally targeted.

Remember all the paper profits you lost when the Nasdaq crashed? Don't feel too bad. The Millers not only lost their dot-com quicksilver; thanks to the AMT they owe tax on it, too.

"Our hearts couldn't take it any longer," Rita Miller, 59, says of the moment two years ago when they caved in and agreed to pay the tax. "We said, `That's it. We'll cash whatever. We'll turn in our retirement. Just end this nightmare.' "

The nightmare, however, continues. The IRS doesn't just want the $117,000 the Millers are supposed to owe on income that never existed. It wants more than $200,000, including interest and penalties, and it has rejected every settlement offer they have made.

Unexpected riches

Art and Rita Miller never figured they would even make hundreds of thousands of dollars, let alone owe that much in taxes. They had never owned a share of stock or a mutual fund. They didn't even have much of a savings account.

But they earned enough to move out of Philadelphia, where they married when she was 18 and he 20, and raised three boys in New Jersey. Jobs took them to Buffalo and Albany, N.Y., and then, in 1997, Catonsville, when she signed up as an administrative assistant with a Linthicum branch of VeriSign Inc., a Web security company.

Without knowing it, she had walked into a money factory.

Like every other young Internet company in the 1990s, VeriSign distributed stock options in dump trucks to even low-level employees. After VeriSign shares rose 750 percent in 1999, the Millers began to realize they might become rich. Arthur Miller, 61, calculated the couple could someday be worth $3.8 million if the stock didn't tank.

They knew they were over their heads. So they hired a financial adviser and a lawyer, and the advice was unequivocal: Exercise the options as soon as possible, but hang onto the shares, because they would get tax advantages that way, and who knows how high they'd go, anyway?

It was a doubly terrible idea.

The Millers scheduled option exercises on their calendar, like haircuts. Each time an option became exercisable, they called the broker, had him sell just enough shares at the market price to cover the exercise cost, and saw their paper worth go higher and higher - mostly in VeriSign stock.

Options' value depends on the difference between their exercise price and a stock's market price. Rita Miller was getting thousands of options with exercise prices of $4 and $6 a share, and VeriSign's stock was heading toward $250.

Under the regular tax code, for the kind of "incentive" stock options that she held, that value would not have been taxed until the VeriSign shares were sold. But under the wacky AMT rules, holding shares after the end of the calendar year triggered a large tax based on the difference between the exercise and market prices at the time of exercise.

(Incentive options are different from the "nonqualified" options most employees get.)

Arthur Miller says their tax lawyer had no clue about this. But VeriSign tried to educate employees, and sometime in early 2001, the couple realized they were going to have a very large tax bill.

Problem was, they no longer had the wherewithal to pay.

Like every other Internet stock, VeriSign was crashing and taking the Millers' paper wealth with it. By March 2001 VeriSign had plunged back to $40, en route to $6, but the tax bills stayed stratospheric.

The AMT system allowed people like the Millers to recoup excess stock-option liability by taking credits against tax owed in future years - but only up to $3,000 a year.

The Millers couldn't pay the whole AMT without selling their house or cashing their retirement annuities and incurring big penalties. And even if they had, she says, "we were going to be 97 and 99 when we got all our credits back, and I doubt I would have lived that long."

Thus the ordeal began.

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