By |Published On: May 6, 2024|Categories: Alternative Minimum Tax, Financial Planning, ISOs|

Exercising ISOs in a high income year is part of a well thought-out stock comp strategy. Last week we had a great time kayaking on the Delaware (AMT Threshold), but now it’s time for a much bigger challenge! We are going out west to Colorado (ISOs in a high income year) to take on some Class 5 rapids and do it on the day that there is “a release.”

Get your wetsuit, your helmet, and buckle up!

High Income Windfall

First up, it’s great to celebrate when you have a high income year! Second, it’s even better to understand what to do with this opportunity, so you don’t leave money on the table. Your substantial income increase can come from a variety of sources – promotion, salary increase, NSO exercise, RSU vesting, or a successful IPO.

Next, we will walk through an example so you are keen on how to plan around it.

In Depth Example

For example, your annual income is typically $500,000, but this year your income is $3,000,000 from a successful IPO at your company!

With a higher income comes higher taxes. However, there are some opportunities to plan around an increase in taxes – believe it or not. In each of the years, you will pay the Total Tax number (the number on the bottom of the table).

Typical YearAwesome YearAwesome Year - ISO
Regular Tax$117,500$1,050,000$1,050,000
6251 Adjustment$0$0$775,000
Tentative Min. Tax$110,500$840,000$1,050,000
Total Tax$117,500$1,050,000$1,050,000

In the Awesome Year, your Tentative Minimum Tax ($840,000) is a lot lower than the Total Tax ($1,050,000). Because you are going to pay a high amount of taxes – the Total Tax – this is an excellent year to do some ISO planning.

So, with a uniquely high income year, a lot of ISO strategy comes into play. With the proper planning, you can exercise a large amount of ISOs, not pay the AMT, and hopefully use the long term capital gains incentive.

For instance, in the Awesome Year – ISO – you can put $775,000 worth of ISOs into play and still not trigger the AMT. In fact, you’ll be paying the same amount of tax (Total Tax) as you would without exercising a single ISO. Simply put, the Total Tax amounts are the same in Awesome Year and Awesome Year – ISO.

Put Yourself in a Great Position

At this point, exercising ISOs will require a large outlay of cash. However, as an employee who believes in the business and wants more equity ownership, it’s a fantastic time to take advantage of the situation.

When you typically make $500,000, a $3,000,000 year is a 6-fold increase. The cash flow shouldn’t be a problem when it comes to exercising ISOs in a high income year.

There are a lot of moving pieces in this example – ISOs, AMT, other taxes – so let’s set up a time to chat so that you can put yourself in an awesome position year after year, not just this high income one!

Questions?! Hit me up!