Here's something I didn't know that may explain some of the nasdaq extreme action in some stocks.
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<<As we head into year-end, here's one more worry for tech stocks. If ordinary tax-loss selling weren't bad enough, get ready for its virulent mutant cousin: Alternative Minimum Tax-gain selling.
Normal tax selling is something investors choose to do to lower their tax bills a little bit. But AMT-gain selling can force investors to dump their stocks at any price -- or face financial ruin. So when an AMT-gain seller hits the market, it's just like a lockup coming off: Watch out below!
Here's how it works.
Suppose you joined a Silicon Valley technology company a couple years ago. Let's say it went public last year, and you made a killing on your stock options -- at least on paper. For example, the strike price on your options was $5 a share and your red-hot company went public at $12.
The stock traded at $100 in the heady days of February, and you exercised your options to get the clock started for long-term capital gains treatment. Now the stock has fallen back to $25: disappointing, but not a tragedy, considering that it cost you only $5 when you exercised your options.
But here's the rub. When you calculate your tax bill, you may well be subject to the Alternate Minimum Tax. Under AMT, the difference between the strike price of your options and the stock price at the time of exercise is taxable as ordinary income this year, regardless of the fact that the stock has declined since you exercised.
That means you are going to be taxed on $95 of income for every share you exercised (the stock price of $100 at the time of exercise minus the option strike price of $5). Even at the lowest AMT rate of 26%, you'll owe $24.70 per share -- and your stock is currently worth only $25! And that doesn't even begin to look at possible state taxes you may owe.
Like the coyote that has to chew his own leg off to get out of the trap, there's only one thing for you to do: Dump your stock before Dec. 31. Doing that gets you out of AMT treatment on your unrealized gains, leaving you to pay only short-term capital gains taxes on your realized profit of $20 ($25 for your stock, minus the $5 strike price of your options).
So at least you're left with something, although it will be even worse than this if you take into account the market impact of your selling. Will you really get $25 for your fallen highflier? If your position is big enough, and you're desperate enough, will you get $23 ... $20 ... $17? That's when panic sets in, and you call your broker and tell him to hit the sell button, at the market!
How many executives and engineers at how many technology companies are in just this situation, and how many are just realizing it? And how many recent tech stock blowups can be explained by AMT-gain selling? How many are left still to come before year-end?
It's unpredictable which company will be next and which will be exempt. And it's complicated by Securities and Exchange Commission insider-selling rules and company policies that put limits on the timing and quantity of shares that can be sold by different types of employees, present and former. The unlucky ones who are coming to understand their desperate tax situation too late may be forced to sell next year -- not to avoid the AMT, but simply to raise money to pay it!
A milder version of this has happened before. For the past two years, the Nasdaq has made an important intermediate-term bottom right at tax time: This year it was on the filing deadline of April 17, and in 1999, it was four market days later, on April 20. Those bottoms happened because tech-stock investors had to sell stocks to pay their capital gains taxes on realized profits from the previous go-go year.
Well, AMT-gain selling is potentially even worse: There are no realized profits to help pay the tax bill. It all has to come from selling. (For more on AMT and its ramifications, read Tracy Byrnes' columns on TheStreet.com: Dwindling Options: How to Handle Stock Options for Year-End Taxes and Your Taxes: You Don't Have to Be Rich Anymore to Worry About AMT.)
The Fed has changed its bias toward ease, the price of oil is coming down, and the president-elect is pushing for tax cuts. Good things are beyond the horizon. So when AMT selling is all out of the way after Dec. 31, the Nasdaq could be positioned for a powerful recovery. But in the meantime, it'll be a minefield. We'll never know until it's too late which stocks will be hit, or exactly when. >> |
