By |Published On: May 13, 2024|Categories: Alternative Minimum Tax, Financial Planning, ISOs|

Unfortunately, on the river this week, we hit a rock – the AMT (Alternative Minimum Tax). We exercised our ISOs (Incentive Stock Options) and now we have to pay a big AMT bill. We will go through what to do about ISOs and the AMT.

Not all is lost. Although we hit a rock and we have to pay the AMT, our boat didn’t sink! We will get some AMT credit in the future.

In addition to the AMT, there are several other considerations with exercising ISOs.

ISO Considerations

For example, your immediate financial objective is to exercise your ISOs and hold every single one of them for the long term capital gains benefit. With this strategy, you must think about your cash flow, increased company ownership, and the AMT credit.

First, exercising options can be expensive. You have to spend cash to exercise the ISOs and have additional money on hand for the AMT.

Second, if you are not selling the shares right away and you hold them for the long term, you will be tying up your capital. In addition, taking on more company ownership increases your investment risk.

Last, there is a potential delay in AMT credit, even if you hold the shares for the required time period – at least another year – to qualify for long term capital gains taxes.

Example with ISOs and the AMT

Here’s an example that illustrates the points mentioned above.

In this instance, you have 10,000 options with a strike price of $1 per share. The current stock price is $201 per share.

When you exercise all 10,000 options, the cost is expensive – $2,000,000. Plus there will be an AMT of $574,958. So you’ll need $2,574,958 on hand for this decision in Year 1.

Year 1Year 2
Regular Tax$117,500$503,584
6251 Adjustment$2,000,000($2,000,000)
Tentative Min. Tax$650,585$66,777
AMT Credit$0$403,234
Total Tax$650,585$66,777

You’ll notice in Year 1 that the bargain element / 6251 adjustment is $2,000,000. Because of the bargain element you will pay the AMT of $574,958. In Year 2, the bargain element / 6251 adjustment is offset for the same amount.

However, the AMT credit amount in Year 2 ($403,234) is much lower than the AMT paid in Year 1. You won’t get the entire AMT amount back into your pocket.

Although the total tax paid in Year 2 ($66,777) is substantially lower than the total tax paid in Year 1 ($650,585), exercising ISOs is a large cash outflow. However, if your company performs well and the stock price increases, it could be worth it.

This example shows how complicated ISOs can be. To get a clearer picture about your ISOs and the AMT be sure to consult the appropriate professionals – a financial planner and a CPA.

Do you have more questions about ISOs and the AMT? Let’s chat.