When you exercise your incentive stock options (ISOs) you may need to pay an alternative minimum tax (AMT).
The difference between your strike price and the fair market value (FMV) of each share is considered a form of income for purposes of your AMT payment.
An AMT credit is a reduction you may qualify for if you paid AMT in previous years.
Exercising ISOs and AMT
The moment when you finally get to exercise your stock options is an exciting one, but it can also be an expensive one. If you have employee equity and you choose to exercise your stock options — in particular, if you have incentive stock options (ISOs) — you may find that you owe alternative minimum tax (AMT). However, if this is not your first rodeo, you may qualify for an AMT credit.
AMT is a complicated system of taxes that hums along in the background and most people never have to factor AMT into their tax landscape. However, in the case of exercising ISOs, the IRS may view the paper gains you have earned when you exercise your options as a taxable event subject to the AMT. But don’t despair, consider having a tax issue like this a good thing because it means you’re earning money. Well, paper money. (Ok, sad trombone, we know.)
🤓 Lawyer Pete made us do it: This article is for general informational purposes only (and we have a couple of additional disclaimers you should keep in mind, posted at the end of this piece). If you have questions about your specific financial situation, you should speak with a professional advisor.
What is AMT?
AMT is the minimum amount of taxes someone must pay no matter how many credits or deductions they can claim for that tax year. The AMT applies to those who earn above a certain income threshold. For 2022, the AMT exemption amount is $75,900 for single filers and $118,100 for couples filing jointly and the income at which exemption begins to phase out is $523,600 for single filers and $1,047,200 for couples filing jointly.
AMT includes more income items and allows fewer deductions than the regular tax calculation. To find the final taxable figure, preferential deductions are added back into the taxpayer's income in order to calculate their alternative minimum taxable income (AMTI). Next, the AMT exemption is subtracted, which brings us to the final taxable amount.
👉 Is your head spinning? Yes, it’s complicated and a very good reason to enlist a good accountant or option funder to help you determine and cover this cost.
How is AMT calculated?
Oh boy, we'll do our best to explain. AMT represents the excess of the tentative minimum tax over the regular tax. You will only owe AMT if the tentative minimum tax for the year is greater than the regular tax for that year.
To calculate your AMT, you can use tax software which will crunch the numbers for you.
👉 To make it easy to calculate how much AMT you may owe, check out the AMT Tax Calculator.
Or you can fill out IRS Form 6251, which takes miscellaneous deductions and things like medical expenses and home mortgage interest into account to determine if your deductions surpass the IRS limit. To complete this form you will also need to share information on other types of income like investment interest or tax refunds.
When do you owe AMT on ISOs?
What are AMT credits?
An AMT credit is a type of reduction you may qualify for if you paid AMT in previous years. It’s fairly common for AMT to be triggered when exercising ISOs, so if you exercised ISOs in recent years you may be eligible for AMT credits. There is no expiration date for these credits, but there may be limits on the number of credits you can use in any given tax year.
This could be welcome news for people at their second or third startup. We highly recommend speaking with your tax advisor on the ins and outs of your taxes and credits for a complete picture of how you could be affected.
👉 Pro-tip: If you use option funding with Vested, we cover both your exercise cost plus the related tax bill.
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for investment, tax, legal, accounting, or other professional advice. Vested does not provide investment, tax, legal, accounting, or other professional advice. You should consult your own investment, tax, legal, accounting, or other professional advisors before engaging in any transaction or equity decision.