Incentive Stock Option Owners: Know your AMT Crossover Point

There are many benefits to exercising and holding your incentive stock options (ISOs). In addition to significant tax reductions, holding vested shares gives you flexibility and control. But the more shares that you exercise and hold each year, the more likely you will reach the crossover point at which your Alternative Minimum Tax (AMT) tax calculation becomes higher than your Regular Tax calculation. Much higher!

ISOs are unlike other forms of equity compensation because when they’re exercised, you don’t receive cash (unless you are able to and decide to sell them immediately). If you hold your shares for more than two years from the grant date and more than 1 year from the exercise date, you are eligible for the IRS’s capital gains tax rate (ranging from 0% to 20% depending on income) versus the higher ordinary income rate of up to 37% (and higher if you include state income taxes).

However, in your efforts to reduce your future tax rate liability, you may end up with an unexpected current-year tax liability; AMT. This tax is a parallel calculation that is part of your individual tax return each year. If you exercise and hold ISOs, the IRS can tax you on the difference between the market value of your company shares and your ISO strike price (even if it is a private company).

This can be particularly difficult because when you exercise and hold ISOs, you pay taxes but don’t receive cash. You receive cash when you ultimately sell your share but that may be several years later (sometimes years later). The more ISOs that you exercise and hold, the more likely you will crossover from your regular tax liability to a higher AMT liability.

If you are bullish on your company’s initial public offering (IPO) prospects it may be acceptable to incur some AMT when exercising your options. The incremental AMT amount you paid above your regular tax is recoverable in the form of credits which you can recover each year. This becomes more of a ‘timing’ issue where the credits are paid out over multiple years until extinguished. That said, you may only take credits if you are not liable for AMT in any given tax year and it may take years before you can recover AMT paid.

Identify your AMT crossover point!

1. Establish a long-term ISO strategy as part of your overall stock options strategy. See my prior post: How Much Equity Comp (ISOs, RSUs, NSOs, EPPs) Should You Keep?
2. Identify your AMT crossover point for your ISO. We’ve created a spreadsheet template to calculate individual AMT crossover points to avoid tedious IRS tax law interpretation. We’d be happy to assist!
3. Establish your multi-year ISO strategy. There are many strategies to exercise options for the lower capital gain tax bracket. This could include an early exercise or exercising options across multiple years to stay under your AMT crossover points.

If you would like to explore this subject further, please schedule me and my team here.