Tech Workers’ Stock Options Turn Into Tax Nightmares

Thousands of technology workers are facing huge tax bills by Monday’s income tax filing deadline because of company stock they purchased last year that has since plummeted in value.

Accountants and politicians from Silicon Valley to Boston say they have been inundated with horror stories about shares purchased with employee options that workers once had hoped would make them rich. Instead, the shares saddled them with big tax bills on profit they never saw.

Many of these workers now owe far more in taxes than their stock is worth. Former Cisco engineer Jeffrey Chou, 32, owes $2.5 million in taxes on company stock he purchased last year that has since withered in value. Chou figures that if he were to sell everything he owns, including the three-bedroom townhouse that he shares with his wife and 8-month-old daughter, the family still could not pay the bill.

“I’ve lost sleep. I can’t eat. I cannot pay and we’re ruined,” Chou said.

The one thing sustaining Chou is a small but growing movement among the financially devastated workers to try to change the rules that snared them. But the issue is an uphill battle legislatively because of a widespread perception that the victims were done in by their own greed or bad planning: In essence, they played the option lottery and lost.

“This is not the most politically compelling story,” one congressional staffer said.

Many of the affected workers, however, said they believed they were doing the right thing by exercising options and then hanging on to the stock instead of selling it for quick profit. Some did not understand the tax implications of their stock purchases, and many said they wanted to show loyalty to their companies.

“There was this feeling of ‘hold on to it for the long term,’ ” said Marilynn Goldberg, an unemployed executive recruiter who faces a $500,000 tax bill from Portal Software Inc. stock she purchased using options last year; the stock has fallen more than 80% since then. “You have to remember, it’s a new phenomenon. A lot of the people [using options] had never had them before.”

What also rankles is the idea that top management may have escaped this pain. Accountants say that some companies have allowed their executives--although not typically their rank-and-file workers--to cancel stock purchases made last year if the shares subsequently declined. The Securities and Exchange Commission has said the practice is legal but told companies they must record an expense that will lower their reported profit. In addition, the companies must disclose the cancellations in future annual reports. So far no companies have made such cancellations public.

Portal Software and Cisco say they are not among the companies that rescinded executive stock sales.

“We do not undo stock transactions after the fact,” Cisco spokesman Steve Langdon said.

There are two kinds of options that companies use to reward workers: incentive options and the more common nonqualified options. In both cases, the tax is based on the difference between the low price the employee pays for the stock and its actual value on the day the stock is purchased.

Both have tax consequences, but incentive options can trigger an especially nasty trap for the unaware or the unprepared. Buying stock with these options triggers the alternative minimum tax--a parallel tax system Congress devised to make sure the rich don’t completely avoid taxes.

Chou used incentive options to buy, in one transaction, about 100,000 Cisco shares in March 2000, paying 5 cents to 10 cents a share. At the time, Cisco shares were trading for $62 to $63 each. The difference between the price he paid and what the shares were worth--a total of about $7 million--is taxable to him as profit.

Chou could sell his shares now, but it wouldn’t solve his problem. Cisco closed Thursday at $17.98, which means that his entire stake is worth about $1.8 million. To pay his state and federal tax bills, he needs $700,000 more.

Federal tax law offers an out to those who used incentive options to buy stock last year, but only if the shares were sold before Dec. 31. The employee would still owe taxes, but only on the difference between what the employee paid for the stock and what it was worth on the day the employee sold it. What’s more, the employee would have the money, thanks to the stock sale, to pay the bill.

The problem is that some tech workers didn’t hear about the loophole in time to sell their shares. Others said they didn’t believe that their stock would fall so far that they wouldn’t be able to sell it by Monday--the tax deadline--to pay their bill.

That group includes Chou and many of his friends who used incentive options.

“We had faith in Cisco. They were so stable,” Chou said. “I thought this sort of thing only happens to people at dot-coms, not to engineers at Cisco.”

Cisco spokesman Langdon said the San Jose Internet networking equipment maker tries to prepare its employees for the tax implications of options by holding seminars, referring workers to the company’s stock administration department and advising them to seek professional tax help.

Chou and two fellow Cisco engineers, who also face crippling tax debt, have hired a tax attorney to help them deal with the IRS. As tales of tax burdens become more common, Chou and his friend have been contacted by other Cisco employees who, in turn, have tipped them to more people facing the problem. The group is starting to rally people online, using their site https://www.reformAMT.org to gather stories and organize.

Several gathered at a popular Mexican restaurant in Santa Clara on Thursday to swap ideas and attorneys’ names. A business-development manager, who said he hasn’t had a peaceful night’s sleep in months, has spent thousands of dollars on accountants “who still don’t have any answers for me.”

Many of the workers are calling themselves bankrupt, but filing for bankruptcy may not be an option. Tax debt is difficult to wipe out, even in a Chapter 7 liquidation, and usually the tax bills must be at least three years old. Meanwhile, the IRS may try to collect.

“The waiting period sometimes just kills people,” said Charles Rettig, a Beverly Hills tax attorney.

The workers have other options, IRS officials say. They can arrange installment payments to pay their tax bills over time. Or they can throw themselves on the mercy of the IRS, and attempt to settle their tax debts for less than what they owe in what’s known as an “offer in compromise.”

Unfortunately, the IRS offer in compromise system is overloaded and negotiations can drag on for more than a year, lengthening the time these workers will spend in financial limbo. There are no plans to move stock-option users to the head of the line--”they’ll be treated like anyone else” in the program, an IRS spokesman said.

Some tax experts fear the big bills will induce some workers to stop paying taxes altogether. Robert L. Sommers, a San Francisco tax attorney and editor of the Tax Prophet Web site, told a Senate hearing he feared that some workers would “slip out of the system”--either leave the country entirely, or simply fail to file their returns.

Some types of stock-option transactions are not reported to the IRS, so even workers who know they have a tax problem might try to pretend it doesn’t exist, accountants said. That fact raises no small amount of bitterness among Chou’s friends.

“We’re trying to do the moral thing and pay our taxes. Look where it’s gotten us,” said Jaweed Mahmud, 36, a business-development manager at Cisco who said his tax bill is in the six-figure range.

Technology workers aren’t the only ones facing AMT problems. Because Congress didn’t index the AMT system for inflation, a growing number of middle-income Americans have been snared by the alternative tax in recent years. The growth of incentive stock options has made the problem worse.

The congressional Joint Tax Committee estimates that 1.5 million taxpayers will be hit by the AMT this year, but that number is expected to skyrocket over the next decade.

“The AMT is getting more and more out of whack,” said Rep. David Price (D-N.C.). “It was designed for relatively rare instances where one was escaping tax liability altogether . . .. The AMT is beginning to affect people whom it was never intended to affect.”

Congress’ sympathy, however, has yet to extend to helping technology workers.

Rep. Zoe Lofgren, a Democrat who represents part of the Silicon Valley, and 13 other House Democrats from technology-heavy districts introduced a bill to exclude incentive stock-option plans from the AMT. The bill, which would be retroactive to Jan. 1, 2000, is awaiting action in the Ways and Means Committee. Another potential problem for Lofgren’s bill is that the issue hasn’t hit taxpayers in many parts of the country. Although AMT reform has strong partisan support, there isn’t a groundswell of interest in exempting high-tech workers specifically from the parallel tax system, congressional experts say.

Supporters of the bill argue that the victims aren’t rich people. “A lot of them are young, recent graduates,” Lofgren said. “Some of them have been downsized, and in addition to being downsized and having their stock completely tank and be worthless, now they’re being taxed on income they never had.”

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Times staff writer Charles Piller contributed to this report.