Statement of Timothy J. Carlson, Arlington, Virginia

I am writing to request your help in a serious and urgent matter threatening to destroy me and thousands of other hardworking, productive taxpayers.  The IRS has filed liens on my friends’ assets, and is weeks -- if not days -- away from filing liens on my assets also.  After the IRS is done with me, I will be penniless with no apartment or car, and no matter how hard I work I will have to live on less than $1,000 a month for many years, despite having already prepaid over $850,000 in excess of any tax actually owed, a tax rate of over 350%.  And all this because I was honest.

Please allow me to provide some background on who I am, to give some context for the situation I describe below.  My father was a minister and my mother a stay-at-home housewife in a small town in Minnesota.  I worked my way through college and law school pursuing the American dream.  I am currently the Broadband Communications Group Team Leader for Legal Affairs at Texas Instruments.  Prior to that I was General Counsel for Telogy Networks, an entrepreneurial software company.  I am Vice President of Childhelp Virginia (a child abuse prevention and treatment organization) and have worked for years with World Vision (an international charity) in its children’s programs.  Prior to the situation described below, I donated tens of thousands of dollars to World Vision Africa AIDS Orphans projects, DC Inner City work, and to Childhelp.  For years I have supported my retired parents by contributing to the mortgage for their modest retirement home in Minnesota, and have helped to pay for high school and college tuition for several other family members.

I describe my life merely to show the kind of hardworking, productive people being negatively affected by the unintended effects of the Alternative Minimum Tax (AMT) as applied to Incentive Stock Options (ISOs).  I also hope to show you that the ripple effects go far beyond the victims themselves, but also affect their families, their ability to work with and support charitable organizations, and of course their ability to engage in productive and entrepreneurial activities.

After three years of struggling to work out a compromise with the IRS, the IRS has rejected my offer in compromise (OIC) for my 2000 tax liability (more than $1.6 million with penalties and interest).  In a letter I received on June 18, 2004, Joel Goverman, Area Director for the Small Business Self-Employed Office in Baltimore, assured me that the IRS has conducted "a thorough review of [my] particular issue . . . before preparing a final response."  Yet, upon even cursory analysis, the stated reasons for rejecting the offer are so illogical and irrational as to approach the bizarre.  I mean no disrespect to Mr. Goverman, who I realize is just the messenger in this situation and I apologize in advance if my writing becomes too colorful or strident, but the situation is so strange I hardly know how to convey it otherwise.

The first reason stated for rejecting my OIC was that "based on the financial information you submitted, we have determined you can pay the amount due in full."  Mr. Goverman concurred with this analysis and suggested that the Taxpayer Advocate did as well.  However, given the facts, this is nothing short of Kafkaesque.  I have nowhere near the $1.6 million that the IRS currently seeks.  The Taxpayer Advocate determined that the IRS was overestimating my ability to pay by more than $650,000.  I earn less than $175,000 a year and have already offered all of my tangible assets to the IRS.  For years the IRS has insisted I have money I simply do not have. 

Even if I could pay the amount in full, the IRS could, and should, accept my offer based on something called Effective Tax Administration.  "Effective Tax Administration," as Mr. Goverman (and published regulations) noted, "is only applicable if . . . requiring full payment would create an extreme hardship, or if collection of the full liability would be unfair, inequitable and would adversely impact voluntary compliance by other taxpayers."  The second reason stated for rejecting my OIC was that "we have determined that [to accept your OIC] would have a negative impact on compliance by the general public." 

After years in law school and practicing law, I can not understand the "logic" of the assertion that accepting my offer will "have a negative impact on compliance by the general public").  What taxpayer is going to look at my case and think

OK, let me get this straight, I have two choices:

Choice One, under the regular tax code I am not required to pay any tax when I exercise ISOs.  The regular tax code encourages long term investment by offering more favorable long term capital gains rates if hold the stock for at least one year.  Of course, if I report under the AMT code I will owe prepayment taxes that will destroy me and my family, but if I do not report the transaction the IRS is unlikely to catch it because the government has no "checks" or information reporting requirements in place to find out about the exercise.  If I don’t report under AMT I’m not really cheating the system because I haven’t realized a dime in profits yet because I haven’t sold the stock, and I intend to fully pay my regular taxes once I do so.  Technically, I suppose this is wrong.  But, by not reporting I avoid destroying my life and, in the end, I still fulfill my duties as a citizen and a taxpayer when I sell my stock and then report and pay my fair share of tax.

Choice 2, under the ISO AMT provisions, if I report my ISO exercise and disclose those phantom profits then I will be complying with an unintended quirk in the tax code that makes me prepay based on tax rates that exceed 350% of my actual income.  I can always ask the ‘more friendly’ IRS to please recognize the irrationality at work and give me a ‘break’ by making me overpay ‘only’ 200% rather than more than 350%.  After all, the legislative history relating to offers based on effective tax administration tells the IRS it has broad discretion to accept offers based on public policy. 

Of course, the IRS will reject my offer despite the legislative directive.  It will charge me interest and penalties on the amount I am unable to pay, liquidate all my assets and garnish my wages for several years, leaving me destitute and destroying any incentive I have to work.  It does not matter that the IRS position of not compromising any AMT liability is based on some secret memo that it will not disclose to taxpayers and their representatives.  The AMT I am able to prepay through borrowing and selling other assets, will become a ‘credit’ that will take hundreds of years to recoup at the $3,000 per year maximum.

"So in conclusion, I guess the IRS policy makes a lot of sense; I really should report my ISO exercise and be forced to pre-pay tons of taxes on income I haven’t received yet.  It’s okay that this will mean that I’ll lose my house and car, because I will have millions of dollars of tax ‘credits’ that I can recoup in $3,000 per year increments.  And really, I want to work more than 60 hours a week to live on less than 1/5 of my salary while the rest goes to build up more useless tax credits.  My family will understand that I can no longer contribute to sending the kids to college, and that I will need their help in the years to come because I can no longer save for my own retirement.  I will have the satisfaction of knowing that I reported honestly, while those who snubbed the law and did not report their AMT liabilities enjoy their "ill-gotten" gains."

As is obvious from the imaginary internal dialogue above, in fact this policy to blindly force an outdated, unfair and unjust law in no way encourages compliance, but rather presents taxpayers a Hobson’s choice -- use ‘self-help’ by not reporting ISO exercises or face the blind, financially devastating, life-altering enforcement of an unjust and unintended tax law.

Mr. Goverman suggested that a special Effective Tax Administration Group in Cincinnati had reviewed my file and determined that my offer did not meet the criteria because "the position that the tax law itself is in [sic] inequitable is not a basis for an ETA offer.  As you are aware, the authority to change the tax law rest [sic] with Congress."  Unfortunately, with the exception of the last clause, which properly notes that Congress has the authority to change the law, his statement is patently false.  The Cincinnati committee never received my file because an IRS agent who acts as "the gatekeeper" saw my tax liability was due to the AMT/ISO problem and sent it back.  This agent said that the IRS does not have the authority to accept any compromise of an AMT liability because only Congress can change the law.  The agent could not cite any authority for his statement, nor could he explain how compromising an AMT liability was any different than compromising any regular tax liability.

Moreover, my request for an offer in compromise is not based on the blanket assertion that the AMT law is inequitable.  I have only ever asked the IRS to focus on the individual circumstances of my case.  The only way I could have had the money to pay this exorbitant tax was if I would have sold the stock before it started dropping in value.  Unfortunately, a sale at that point could have subjected me to the risk of insider trading in violation of SEC guidelines.  It is difficult to find a time when I could have sold the stock without risking a possible investigation by the SEC or state attorneys generals because of my position and the rapid and continued decline in the stock’s price.  How can the government stated public policy to encourage strong corporate governance practices if taxpayers must choose between complying with tax law and securities law? 

Accepting my offer in compromise (and, truthfully, those of many others who were caught by the AMT/ISO labyrinthine rules) will encourage voluntary compliance.  Further, it would  and would be more fair and equitable than forcing hard-working, middle class people into bankruptcy to pay a tax on phantom gains they did not receive because they continued to invest in their employers and the economy as the government encouraged when it created ISOs.  Congress has already recognized that the stock market crash in 2000-2001 was a unique event divorced from the normal market risk that investors assume.  Congress has enacted a number of tax cuts and other reforms to stimulate the economy and provide relief to ailing taxpayers.  It should do the same for the hardworking individuals and families who have been financially ruined by the ISO AMT rules as a result of that crash.

My case as described above is not imaginary, and the facts are not hyperbole.  And, tragically, I am not alone.  Thousands of similarly bizarre cases have arisen across the country.  The IRS decision to blindly enforce an outdated, misguided and misapplied AMT/ ISO tax provision (which became even more absurd in the context of the market bubble burst) is ruining the lives of good citizens in practically every state in this country.  

I would never have believed this could happen in America if I wasn’t living through it.  I encourage you to first (1) as an interim measure, instruct the IRS to accept reasonable offers in compromise for ISO AMT liability to prevent honest taxpayers from being destroyed by this tax before proper legislation can be passed, and then (2) adopt focused legislation amending the AMT as it relates to ISOs to restore fairness and justice to a system gone severely awry.  Like me, ISO AMT taxpayers are willing to pay taxes on actual gains and recognize the risks of losing an investment in the stock market.  Our actions and intentions were honorable and consistent with Congressional policy, and hurt no one but ourselves.  In fact, our faith in our companies and refusal to foist losses an unsuspecting public is exactly the kind of behavior the government should encourage -- not punish.   I am not asking the government to replace my lost investment; I am simply asking the government not to collect taxes as if the investment was never lost.