Day 2: ISOs & AMT – What You Need to Know Before Exercising

Understanding the Tax Implications of Stock Options

Day 2: ISOs & AMT – What You Need to Know Before Exercising

ISOs are great on paper—but if you exercise without selling, you might get hit with the Alternative Minimum Tax (AMT).

What Is AMT and Why Does It Matter?

AMT is a separate tax system designed to prevent high earners from paying “too little” tax. It eliminates many deductions and adds back ISO gains as taxable income, even if you haven’t sold your shares.

💡 Example:

• Emma exercises 10,000 ISOs at $5 per share.

• The stock’s FMV is $50 per share—a paper gain of $450,000.

• Under AMT, this $450,000 is added to her taxable income!

• She could owe $100,000+ in taxes—even though she hasn’t sold a single share.

📌 Cited in IRC: AMT rules for ISOs are covered in IRC § 56(b)(3) and IRC § 422(d).

How to Avoid AMT on ISOs

✅ Sell same-year (disqualifying disposition) – This triggers ordinary income tax, but avoids AMT.

✅ Exercise small amounts each year – Spread gains across multiple tax years.

✅ Use AMT credits in future years – You can recapture AMT paid once you sell the stock.

📌 Pro Tip: If you’re at a pre-IPO startup, be very careful about exercising ISOs before a liquidity event—you could be stuck with a huge tax bill and no way to sell shares.

Tomorrow’s Topic: NSOs – The Good, the Bad, and the Taxes

NSOs don’t trigger AMT, but they come with their own tax headaches—especially for high earners. Tomorrow, we’ll cover:

✔️ How NSOs are taxed at exercise and sale

✔️ Why you should exercise strategically to reduce tax liability

✔️ How to avoid tax surprises

Got questions? Drop them in the comments or message me!

Next Articles in the Series

✅ Day 3: NSOs – The Good, the Bad, and the Taxes

✅ Day 4: RSUs – How to Avoid Tax Shock When They Vest

✅ Day 5: Advanced Stock Option Tax Strategies – How to Pay Less to the IRS

Understanding the Tax Implications of Stock Options