If you have incentive stock options, you’ve probably heard of the alternative minimum tax (AMT). Essentially, the alternative minimum tax is a prepayment of taxes. In years when not subject to the AMT, you can receive an AMT credit, which reduces your tax bill to reflect prepaid tax.
The alternative minimum tax can cause a lot of issues for startup or private company employees without liquidity to sell their shares. For early employees with incentive stock options, finding ways to avoid the AMT when exercising ISOs is often key.
This article covers how exercising ISOs can trigger the alternative minimum tax and how AMT credits work (with examples), plus six strategies for employees with ISOs to reduce or avoid AMT.
This article is for informational purposes only and should not be misinterpreted as personalized advice of any kind or a recommendation for any specific financial or tax strategy. This is a general communication should not be used as the basis for making any type of tax, financial, legal, or investment decision. Darrow Wealth Management specializes in equity compensation, including strategic tax planning for stock options, but our work is designed to complement—not replace—the services of a tax preparer. We do not provide tax advice.
Navigating the Alternative Minimum Tax with Incentive Stock Options
- How AMT and AMT Credits Work with ISOs
- How ISO exercises trigger AMT
- Exemptions and phaseouts
- Simple examples of AMT at ISO exercise and applying AMT credits
- 6 Tax Ways to Avoid AMT (or at least reduce it)
- Exercise early in the year
- Exercise late in the year
- Exercise unvested ISOs (early exercise)
- Plan around AMT exemptions, phaseouts, and deductions
- Accelerate AMT credits
- High income exercise
How exercising ISOs can trigger the alternative minimum tax
One major drawback to incentive stock options is the potential to trigger the alternative minimum tax. The AMT is a parallel tax calculation which disallows certain tax deductions and non-taxable items under the regular system. AMT calculation allows just one exemption amount and it phases out with income. Taxpayers pay whichever number is higher: their tax due under AMT or the regular system.
Under the regular tax system, when you exercise ISOs, it’s not a taxable event. But when ISOs are exercised and held through the end of the year of exercise, under the alternative minimum tax calculation, the bargain element (the value of the stock when you exercise minus the strike price) is includable in your alternative minimum taxable income (AMTI) for the year.
This is why it’s sometimes called phantom income.
If incentive stock options are exercised and sold in the same calendar year, then it’s a disqualifying disposition. Early sales of ISOs are only taxed in the regular tax system. But if the shares are kept, you’ll want to track your AMT carryforward credit and dual cost basis.
AMT exemptions and phaseouts in 2026
- AMT exemptions: $90,100 for single filers and $140,200 for joint filers
- Income phaseout ranges: $500,000 to $680,350 for single filers and $1,000,000 to $1,280,400 for joint filers
- AMT tax rates: 26% for AMT-taxable income under $244,500; then 28% (all filers, except married filing separately)
Simple hypothetical examples of AMT and AMT credits
For simplicity, all examples below assume the following:
Tax assumptions
- No other sources of income or capital gains
- 15% flat long-term capital gains tax rate for regular tax and AMT
- 26% flat AMT tax rate
- No 3.8% Medicare tax
- No deductions or exemptions: excludes any standard/itemized deduction or AMT exemption
- No state tax
Grant and sale assumptions
- 100,000 incentive stock options
- $1 strike price
- $7 current value (409a value or market value) at exercise
- $10 sale price
AMT bill at exercise
Regular tax calculation: Exercise of ISOs is not includable in the regular tax calculation so there is no taxable spread or tax due
AMT tax calculation
This fictional example is overly simplified for illustrative purposes. Typically, there’s tax due in the regular system also. In that example, the AMT due would be the excess between the AMT and regular tax due.
Note: If the taxpayer had any income in the regular tax system, it would be reduced by the standard or itemized deduction. The standard deduction would be replace by the AMT exemption (if allowed) in the AMT calculation as well as some itemized deductions.
AMT credits: calculating tax due and credits at sale
There is an AMT silver-lining: in years not subject to the AMT with regular capital gains, an AMT tax credit may be available. To recoup any prepaid tax, taxpayers must track two different sets of cost basis on their incentive stock options.
Dual cost basis
The tax basis for regular income tax is different from the alternative minimum tax cost basis. When ISOs are later sold at a gain above the value at exercise and strike price the two sets of cost basis are:
- Regular tax basis the strike price x number of shares
- AMT tax basis the market value at exercise x number of shares
Notes on AMT credits:
- The maximum credit in a tax year is the difference between the tax due in the regular calculation and tentative minimum tax. But the credit can’t exceed the carry forward credit available.
- The shares that triggered the AMT at exercise don’t have to be sold to take an AMT credit. The two things aren’t directly linked, though the cost basis differentials may come into play. The calculations will include the taxpayer’s entire tax situation, not just incentive stock option activity.
- AMT credits can only be used in years when not subject to the alternative minimum tax.
- Excess or unused AMT credits can be carried forward indefinitely.
Selling exercised ISOs: calculating gains at sale and applying an AMT tax credit (3 steps)
Following on the previous example, assume after meeting the holding period for a qualifying disposition of ISOs the stock is sold for a gain.
IMPORTANT NOTES!
- Despite appearances of these illustrative examples, they are actually quite simplistic. The AMT calculation is very complex. Consulting a qualified tax advisor is strongly recommended.
- Examples assume a very limited set of facts and assumptions, refer to the list above.
- Examples are hypothetical and overly simplified! Not tax advice!
Tax Planning for ISOs and Stock Options
6 Ways to Reduce or Avoid AMT With ISOs
Triggering the alternative minimum tax isn’t the end of the world, but you don’t want to do it by accident. Now that you know how AMT works, here are six strategies to manage, reduce, or avoid the alternative minimum tax when exercising incentive stock options.
1. Exercise ISOs early in the year
To get long-term capital gains tax treatment, you need to hold ISOs through the end of the year of exercise. This is what exposes you to possible AMT. But exercising early in the year can help in some situations, especially for public company employees:
- You exercise in January, 1 year after grant. By December, your CPA and financial advisor can help in developing a tax projection for the year. It should include whether you’ll trigger the AMT, and if so, the projected amount of tax due.
- If the stock is publicly traded and you’re not in a post-IPO lockup, you could sell before the end of the year. That would result in a disqualifying disposition but no AMT. You’d have liquidity from the sale to pay any tax due in April.
- Alternatively, and again assuming there’s a liquid market for the shares and you’re not subject to restrictions, you could hold the stock and sell in January of the following year. While it wouldn’t help you avoid AMT, you could still pick up a qualifying long-term holding period (again assuming you meet all the holding requirements) and also be able to sell in time to raise cash to pay the tax.
- Monitoring the stock price is another potential benefit of exercising early in the year. Remember, the AMT calculation uses the spread at exercise. If the stock drops significantly during the year and you keep holding the shares, you could still trigger the AMT at the old, much higher, valuation. In that case, it may make sense to take a disqualifying disposition.
If you work for a private company, startup, or are early-exercising unvested shares, this strategy likely won’t help much as you won’t have the ability to control the timing of future stock sales.
2. Exercise at the end of the year
Exercising at the end of the year can also yield tax planning opportunities for incentive stock options and AMT, especially for employees of private companies.
By the end of the year, you already know most of the tax inputs so your CPA and financial advisor can help in developing a tax projection. This will enable you to make a decision about whether to exercise before doing so. And (hopefully) you’ll have good data on whether you’ll trigger the AMT and your cash needs. This is important since unlike the prior example, employees at pre-IPO companies don’t typically have a market to sell their shares. So there’s no ejection button if things go south.
For employees of private companies, cash considerations are often the biggest hurdle. If you have a low strike and a big spread, how will you get liquidity to pay the AMT? Or if there’s no spread, but you joined a mature start-up and the strike price is $10/share, how will you get the cash to exercise even 100,000 shares? The cash crunch is quick to rain on a potential tax planning parade.
3. Exercise early (before vesting) to reduce AMT spread
For private company start-up employees, early-exercising unvested shares may be able to reduce tax with an 83(b) election. An early exercise can also start the clock on the holding period for long-term capital gains.
With an 83(b) election, taxpayers elect to accelerate the tax treatment of exercising their options, even though the shares haven’t vested. That’s key because at grant, the strike price usually equals the current fair market value of the stock. If exercised immediately and timely filing of an 83(b) election, there may be an opportunity to have a $0 spread for AMT. And here, there are still no federal tax implications.
Like any strategy, this is not without risk and potential tax implications. For example, M&A activity can cut your holding period short. Or you leave and the shares don’t vest. Also, non-qualified stock options are usually more advantageous for early exercises given the one-year time frame for long-term capital gains.
4. Tax planning around AMT exemptions, phaseouts, deductions, and tax rates
Taxpayers under certain income levels can take advantage of AMT exemptions. Before exercising stock options, work with your CPA and financial advisor to assess the impact of potential exercises. It can be possible to structure an exercise to stay under (but close to) the threshold where AMT would be triggered. A big part of this strategy is often ensuring you exercise only so many shares as to remain eligible for AMT exemptions.
If you’re in the AMT exemption phaseout zone, it might be beneficial to avoid realizing long-term capital gains in some cases. But note, there can be some strategic tax planning opportunities when the exemption is fully phased out. That can happen when the top income tax rate (37%) is compared to the flat 28% AMT. So in some cases, it can actually make sense to accelerate income.
Another potential strategy to consider discussing with your tax advisor are your tax deductions. In the AMT calculation, some itemized deductions are permitted, such as the deduction for mortgage interest (subject to regular rules). So as an example of one strategy to consider, when subject to the AMT, it’s sometimes better to itemize tax deductions even if it’s less than the standard deduction (not allowed in the AMT calculation).
As you can see, the tax planning opportunities, rules, and caveats are very intricate and complex. Consulting a tax advisor to discuss your situation is highly recommended.
5. Claim AMT credits faster
Strategic selling. Most executives with stock options have different grants with various strike prices and cost basis on their shares. (Recall earlier discussion on dual cost basis and AMT adjustments!) Essentially, when you trigger the AMT, the larger the spread at exercise, the more tax you’ll prepay. This, in turn, means you can have a larger AMT credit to (hopefully) provide a negative adjustment in years when not subject to AMT.
Therefore, when considering what shares to sell and when, it can help to be choosey. The shares that initially created the biggest positive AMT adjustment at exercise could provide the best opportunity to use more of your AMT tax credit that tax year. While the exact ISOs that created the AMT liability don’t have to be sold to recoup it in a credit, due to the cost basis differentials, selling those shares can help facilitate taking larger credit later on. Because it can take years for taxpayers to fully absorb their AMT credits, this is an important planning consideration.
Matching exercises with sales. In conjunction the strategic selling, also look into matching ISO exercises with sales to reduce/offset the AMT. If you sell ISOs and realize a large negative AMT adjustment for the year, consider pairing a new exercise the same year. The negative AMT adjustment from the sale can reduce the positive AMT adjustment, enabling you to potentially still utilize some of your AMT credit (although a smaller amount due to the exercise) or trigger the AMT but mitigate the impact.
6. When your regular taxable income is already high
Due to the AMT tax rates (26% and 28%), exercising ISOs during a year where taxpayers already have high ordinary income (37% is the top rate in 2025 and 2026) is another way to potentially avoid triggering the AMT. So if you have a large windfall from a bonus, vesting RSUs, exercise (or sale) of non-qualified stock options or income in connection with a restricted stock award, it might be a good year to consider exercising ISOs. Again, you’ll pay the higher tax under either calculation. Run the numbers to find out.
At the end of the day, all of the tax planning opportunities with ISOs involve risks. There’s a risk the tax laws will change, your tax situation will be different than expected, and of course, the risk that the stock doesn’t perform as you hope. The focus of this article has been on the alternative minimum tax and ways to avoid it, but the investment implications shouldn’t be overlooked.
Stock option advisors
Darrow Wealth Management specializes in stock options and equity compensation. If ISOs are a big part of your wealth, consider working with a stock option advisor experienced with strategic equity planning, tax implications, and strategies to best manage sudden wealth.
Tax Planning for ISOs and Stock Options
[Last reviewed January 2026]
