The alternative minimum tax (AMT) is a tax you may owe when exercising your incentive stock options (ISOs). Your AMT builds up in parallel to your regular tax liability. After all your taxable income and deductions are taken into account, you pay either the AMT or your regular tax bill (whichever is higher).
Upon exercising your ISOs, you will likely owe AMT.
It’s important to note that you may also owe alternative minimum tax (AMT) upon exercising your ISOs. The AMT is a separate tax system with different rules designed to ensure that high-income taxpayers pay at least a minimum amount of taxes. When you exercise your ISOs, you will likely owe AMT if the spread between your exercise price and the FMV of the shares at exercise is large enough. You calculate this spread using Form 6251.
AMT Calculation #
The AMT is calculated based on the bargain element (aka spread).
Bargain Element = (FMV at Exercise) – (Exercise Price)
FMV at Exercise is either the:
1. Private Company = 409A valuation
2. Public Company = Stock Price on the Stock Exchange
You owe AMT if your total bargain element x total ISOs exercised > exceeds the AMT exemption amount
If the tax you owe under the AMT calculation exceeds the tax you owe under regular tax calculations –> You will have to pay AMT when you file your tax return for the year that you exercised your ISOs.
Beware of under-withholding from the exercise of ISO stock.
There are no withholdings from the exercise of ISOs so if you owe AMT taxes, then plan accordingly. In other words, although, withholding is not required on ISO exercises, the income is taxable income.
Calculating the Alternative Minimum Tax #
The AMT has two tax rates depending on the amount of AMT taxable income.
AMT Standard Exemption #
The American Taxpayer Relief Act of 2012 enacted a permanent AMT fix by establishing a higher AMT exemption amount, indexing the AMT parameters for inflation, and allowing specified tax credits under the AMT. The IRS publishes the AMT exemption amount in their Instructions to Form 6251. If the result of this calculation is that the AMT is higher than the regular tax, then you pay the AMT amount plus the regular tax.
