I'm narrowing this problem down. The first time I started having this problem was right after hooking up VFD which gave me ability to do semi-rigid tapping. I spent a week chasing noise issues but couldn't find anything and realized that it has something to do with motor acceleration. In my troubleshooting I disabled spindle control and things were working normally which is why I originally concentrated on VFD. One thing clicked today. It has to do with spindle spin up delay.
When spindle control is disabled mill runs fine; spindle goes down and right back up. In automatic spindle control MACH uses spin up delay. In this mode spindle goes down and stops, spindle starts in CCW, comes up ~0.060" waits for the amount of spin up delay, attempts to move up and this is where the stepper stalls.
So, I removed the spin up delay for CCW (tap retract) and now it works fine without stalling. This is O.K. because of the floating holder but I am really curious as to why I have a problem if there is a spin up delay in CCW direction. I could see this becoming a problem based on the RPM and the amount of float in the holder.
Hood, there is no need to test the g-code, I think I ruled it out. Thanks.