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One item described in part VI is ISOs. Specifically,
section 56(b)(3) provides that “Section 421 shall not apply to
the transfer of stock acquired pursuant to the exercise of an
incentive stock option * * *. The adjusted basis of any stock so
acquired shall be determined on the basis of the treatment
prescribed by this paragraph.” Under section 421, an individual
who exercises an ISO is not taxed on the exercise but is taxed
when he or she sells the resulting stock. See sec. 421(a).
Thus, pursuant to sections 56(b)(3) and 421(a), petitioners were
required to recognize the following income or loss on the
exercise of petitioner’s ISO in 2000 and the sale of the
resulting stock in 2001: For 2000, zero and income of $2,086,009
for regular tax and AMT purposes, respectively; for 2001, a
capital gain of $148,461 and a capital loss of $1,937,547 for
regular tax and AMT purposes, respectively.
Petitioners assert that section 56 entitles them to deduct a
net operating loss for 2001 equal to the $2,086,009 difference
(as rounded) between the 2001 regular tax capital gain of
$148,461 and the 2001 AMT capital loss of $1,937,547. To this
end, petitioners argue, the $2,086,009 difference is an AMT net
operating loss within the meaning of section 56(d)(2)(A)(i) and
allowing such a deduction comports with legislative intent,
equity, and policy. In Merlo v. Commissioner, 126 T.C. 205
(2006), the Court recently rejected similar arguments made by the
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