AMT and ISOs: 6 Steps to Minimize Alternative Minimum Taxes from Incentive Stock Options

Key Takeaways:

The Alternative Minimum Tax (AMT) is an additional tax created to make sure high-earners who get certain tax breaks still pay a sufficient amount of taxes. 

For tech executives who have a large pile of stock options, particularly Incentive Stock Options (ISOs), AMT can get tricky.

You can trigger thousands of dollars in AMT even if you have not sold your company stock yet!

This article will help you understand what AMT is, what triggers it, and proactive financial planning you may be able to do to legally lower the taxes from exercising your Incentive Stock Options (ISOs).

First, let’s cover what AMT is, why AMT was created, and when you are most at risk of triggering AMT.

What is AMT (A Practical Example)

If you have Incentive Stock Options (ISOs), you can often buy your company stock for a lower price than the market.

For example, your company’s stock sells for $50 at market value, but you can buy at $10 per share (your strike price).

You exercise your options and buy your company’s stock at the strike price ($10). On paper, you think you won’t owe any taxes because you have not sold your stock yet. 

But here’s the catch:

For regular taxes, that theory is true! But AMT steps in to say: 

“Wait a minute. You just gained $40 per share (in paper value). You should pay some taxes on those gains.” 

Even though you have not sold your company stock, AMT can treat that “immediate gain in stock value” as income.

This phantom income doesn’t show up on a regular tax return, but it can trigger a substantial AMT bill for high earners with a large portion of their money invested in one company (known as concentrated equity exposure).

This is why the AMT catches many high-earning tech executives off guard!

Why AMT Was Created (And The New Challenges)  

Originally, AMT was designed to make sure high-earners don’t use too many tax breaks or loopholes to avoid paying their fair share of taxes. 

The challenge is that over time, inflation, and rising wages made more people susceptible to getting hit with AMT. 

The 2017 Tax Cuts and Jobs Act reduced the chances high-earners would need to pay AMT. New tax laws recently extended this reduction

However, tax laws can change and it’s important to understand how they apply to your specific financial situation and equity comp package. 

We recommend speaking to a CERTIFIED FINANCIAL PLANNER® or your CPA to get a detailed plan on how to plan for AMT. 

When Are You Most At Risk Of AMT?

AMT is more likely to apply in years when you: 

1. Earn a high income (~$200,000 – $300,000+)
2. Sell an investment for a big gain (a “realized capital gain”)
3. Exercise stock options that are worth a lot of money

This means if your earnings or stock option exercises go above certain levels, you are more likely at risk of owing AMT and triggering a tax bill. 

Capital Gains Tax & Why It Matters With Your ISOs 

To pay lower taxes on your Incentive Stock Options (ISOs), you need to understand how Capital Gains Taxes impact the equation, too.  

Capital Gains Tax (CGT) is a tax you pay when you sell something valuable (shares, a house, or other investments) for more than you originally paid for it. You will only be taxed on the profit (the “gain”), not the full sale price. 

In most cases, the rate for long-term capital gains is a lower tax rate than regular income tax. 

Here is a simple example to help you understand the impact of different tax treatments (capital gains tax vs. regular income tax). Imagine two people who earn similar amounts: 

1. Eric earns $300,000 per year for his salary (regular income)
2. Sarah earns $300,000 by selling stocks she’s had for over a year (long-term capital gains)

Even though they both earned the same amount on paper, Eric will pay more in taxes because regular income has a higher tax rate. Long-term capital gains have a lower tax rate.

Assets held for less than a year are taxed like regular income. But, if you hang on to the assets for at least 12 months, you can get a tax perk!

ISOs: Qualified vs. Disqualified Dispositions

As you can see, timing matters a lot when thinking about how to minimize the AMT on your ISOs. 

There’s one more curve ball to consider: Qualified vs. Disqualified Dispositions.

The length of time you hold on to your ISOs matters a lot when it comes to how the IRS sees your tax bill and if AMT is triggered. It also impacts the amount of capital gains tax (CGT) you may need to pay. 

Depending on how long you hold on to the shares you purchased, it will impact how much you’ll need to pay in taxes. 

• A qualified disposition happens when you hold your ISO shares for at least 1 year after exercising and 2 years after the grant date. This will result in a lower capital gains tax on the sale because you held the asset.
  
• An disqualified disposition is when you sell too soon, and the gains are taxed at regular income.
  

For example, if someone exercises ISOs in January and sells the stock that same year in June, that’s a disqualified disposition and triggers higher taxes.

If you sell too soon, you’ll be charged regular income tax on your gains, whereas if you hold the asset, you are charged long term capital gains tax rates. 

Please Note: The IRS distinguishes between qualifying dispositions and disqualifying dispositions based on timing. To qualify for long-term capital gains treatment, you must meet both of these holding requirements: at least one year after exercising your ISOs and at least two years after the original grant date (the date your company gives you the right to buy stock at a fixed price). Selling the stock before meeting either timeline results in a disqualifying disposition, where part of the profit is taxed as ordinary income. This distinction also affects how your gains are reported on your tax return, often shifting from capital gain treatment to wage income on your W-2.

Six Ways to Mitigate AMT Risk 

As you can see, the AMT can cause some people to lose sleep around tax time. There are multiple items to juggle to lower your AMT liability or avoid it altogether.

Here are our favorite six strategies:

1. Exercise ISOs early in the year. 

Selling shares after exercising ISOs creates a taxable reporting event. 

Exercising then holding the shares early in the year might be a good idea if you need to manage a cash flow burden from the taxes triggered by AMT. There are two reasons why: 

The first has to do with the one-year holding period requirement to sell the shares as a qualifying disposition – a qualifying disposition allows you to sell at relatively low long-term capital gains rates. By exercising early in the year, you start that one-year requirement sooner.

The second reason is that you may be able to sell shares as a qualifying disposition before taxes are due – that means you can use the proceeds from the stock sale to cover the pending tax due. 

For example, you could exercise ISOs in January of the current year, hold them until you sell (at least one year and one day later), then use the proceeds from the sale to cover the tax bill due the following April.

Exercising early in the calendar year lets you monitor the stock price in the months following. 

If the share value is higher by year-end, you might be better off holding them for a qualifying disposition early in the following year. If the stock price drops, selling sooner could make more sense since you will likely just face ordinary income tax rates on the disqualifying disposition, and no AMT.

The value of this strategy is more apparent once you understand your total income for the year.

2. Exercise and hold ISOs when the spread is low. 

You may be able to lower the AMT impact simply by exercising ISOs when the price difference between the options’ exercise price and the stock’s fair market value is small. A lower spread between the two prices means a smaller AMT adjustment on your tax return. The adjustment may be so minor, in fact, that you can exercise and hold ISOs without owing AMT altogether.

Exercising and holding ISOs with a small spread may be an attractive strategy for individuals who received stock options from a pre-IPO company with a low internal market value. It’s also a risky play since you are a long time away from a possible liquidity event. Moreover, you may want to consider this strategy if you are eligible for an early-exercise 83(b) election of your ISOs.

3. Be mindful of the Alternative Minimum Phase Out. 

The AMT is calculated differently from the figures used to determine your regular tax obligations. 

The calculation includes an AMT exemption and an AMT phaseout range at certain income levels. Generally speaking, when your income for figuring the AMT enters the phaseout range, you lose $1 of exemption for every $4 of income until the exemption is zero. The impact on your AMT means a higher effective tax rate in the phaseout range.

While the typical flat tax rates of 26% and 28% for determining AMT are still used, the income amount subject to taxation is higher because of the phaseout – which leads to an effective AMT rate of 35% in the phaseout range. We want to avoid that when possible.

The AMT phaseout range may also impact the taxability of long-term capital gains for years in which you are subject to AMT, potentially increasing your effective tax rate from 20% to 26.5% or 27%, based on your circumstances.

If you know you’re entering the phaseout zone, it might be worth deferring other sources of earned income or planning the timing of other taxable events. Strategic timing can help you avoid a steep tax bill tied to a seemingly minor increase in taxable income.

4. Plan for the Alternative Minimum Tax Credit and the AMT carryforward. 

Suppose you exercise and hold ISOs and pay AMT. In that case, it’s possible to recover the AMT in future years by way of an AMT credit. We can plan for this. 

Let’s say you have multiple qualified ISO shares with differing regular cost basis (exercise price of the stock) and AMT cost basis (share price at exercise). You may be able to pick and choose which share lots to sell so that the AMT credit comes sooner rather than later. 

In some scenarios, the total amount of AMT paid could be credited back to you in the year you sell shares.

You might also have carryforward AMT credits for future years (especially if you owe a lot of AMT). Good financial planning in advance of exercising your ISOs and holding shares helps you plan how much AMT credit you may carry forward. It is critical to implement an ISO management strategy with this scenario in mind.

Please Note: If you don’t use all of your AMT credit right away, it doesn’t disappear. Unused AMT credit can be carried forward indefinitely.

5. Exercise and hold your ISOs when selling other Qualified ISOs. 

It might not be possible for you to afford the AMT payment when it’s due at tax filing time – that might stop you from exercising more ISOs even when you would like to do so in order to begin the holding period requirement to secure a qualifying disposition in the future. 

You could, however, sell previously exercised ISOs that count toward a qualifying disposition. Selling qualified ISOs, particularly ones worth at least the fair market value at exercise, may reduce AMT owed and mitigate the cost of other exercises in the same calendar year.

6. Exercise ISOs in a high-income year. 

Years in which you earn a high income can be an opportune time to exercise ISOs and hold the shares. 

In general, tax rates for ordinary income and AMT flatten out as income rises above a certain amount. 

• Ordinary income is taxed at 37% (in 2025) when this happens.
• AMT is taxed at just 28%, though.

Every dollar of earned income creates an additional spread for exercise and holding ISOs.

We find that clients face this situation when there is higher income due to a high bonus payout, vesting restricted stock units (RSUs), exercising other equity compensation (like non-qualified stock options (NSOs)), or going through a double-trigger IPO event.

What To Do Next About Your Risk of AMT

If you plan to take advantage of your ISOs to build long-term wealth, you’ll want to understand the impact of AMT, including:

1. How much you might owe in taxes
2. Proactive ways to lower how much you’ll pay
3. When the taxes will be due on your ISOs
4. Where you’ll get the cash to pay for exercising your options

At Archer Investment Management, we obsess over helping tech executives build a game plan to minimize the impact of AMT. You’ve worked hard for your stock options, and we want to help you keep more of what’s yours.

With proactive financial planning, you can save a substantial amount of money (potentially thousands of dollars) in taxes. But we need to get you a game plan you can feel confident in, so you can take advantage of your equity compensation options. 

Reach out today if you want us to help you see how we can help you lower the taxes you may owe on your stock options due to the Alternative Minimum Tax (AMT) rules. We’ll work side by side with you and your CPA to design a great plan for your equity comp, your income, and your finances.

FAQs: Common Questions About ISOs and the AMT

1. What happens if I exercise ISOs and then the stock price drops?

If you exercise ISOs and hold the shares—but the stock later falls below the market price at exercise—you could be stuck with an AMT bill based on gains you never actually realized.

This is often referred to as “phantom income.” Since the AMT is calculated in the year of exercise, you could owe tax even if the value of your shares decreases or becomes worthless later. That’s why timing, diversification, and cash flow planning are so important when managing equity compensation and paying taxes on ISOs.

2. Can I avoid the AMT altogether by selling the shares right after I exercise?

Yes, but it comes with trade-offs. If you exercise and sell the shares in the same calendar year, the transaction becomes a disqualifying disposition, and you avoid triggering AMT.

However, the gain is then taxed as ordinary income, not at the more favorable long-term capital gains tax rates. This can help with cash flow and simplicity, but you miss out on potential tax savings if the shares appreciate further and qualify for long-term capital gain treatment.

3. Does the AMT apply every time I exercise ISOs?

Not necessarily. The AMT only applies if your income—including the bargain element from the ISO exercise—exceeds the AMT exemption and begins to phase out. If the spread between your ISO exercise price and the market price is relatively small, or your overall taxable income remains below the threshold, you may not trigger AMT at all. That’s why exercising when the spread is low—or spreading your exercises across several years—can be a smart strategy.

4. How can I use AMT credits to recover taxes I’ve already paid?

Exercising and holding ISOs in a year when you’re subject to AMT could make you eligible to recover some of that tax through an AMT credit in future tax years.

This credit can be used to offset your regular tax liability when your AMT is lower than your regular tax. The key to unlocking the tax filing AMT credit often comes when you sell the ISO shares in a qualifying disposition. At that point, the AMT you paid at exercise becomes recoverable—though how much and how quickly depends on your overall tax picture in future years.

5. What’s the difference between AMT basis and regular tax basis, and why does it matter?

When you exercise and hold ISOs, you effectively end up with two cost bases:

• Regular tax basis is what you paid to exercise the options (i.e., the strike price).
  
• AMT basis is the market value of the shares at the time of exercise.

This matters because when you eventually sell the shares, your gain or loss for regular tax purposes is calculated from the lower exercise price, while AMT gain or loss is calculated from the higher market value. Managing these differences can influence when and how much AMT credit you can claim, and it plays a role in how your stock sales impact your taxes later on.

6. If I’ve already triggered AMT once, does that mean I’ll owe it again in future years?

Not always. Paying AMT in one year doesn’t automatically mean it will apply again.

Each tax year stands on its own, and whether you trigger AMT depends on your income, ISO activity, and other tax items in that specific year. However, if you still hold the ISO shares from a previous early exercise and sell them later, you may recover some of the AMT you paid as a credit.

Disclaimer:

Please consult with your CPA to understand how these strategies apply to your specific tax situation.

Editor’s Note: This article was originally published in September, 2022. It has been updated to reflect 2025 data.