Alternative Minimum Tax(AMT) + Incentive Stock Options(ISO) - John R. Dundon II, Enrolled Agent
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Alternative Minimum Tax(AMT) + Incentive Stock Options(ISO)

Alternative Minimum Tax(AMT) + Incentive Stock Options(ISO)

For Alternative Minimum Tax (AMT) and Statutory Incentive Stock Options (ISO), the date when your rights in the under lying stock are transferable OR no longer subject to a substantial risk of forfeiture you must include as an adjustment for the corresponding tax year a calculation for alternative minimum taxable income resulting from the ISO exercise.  The calculation involves determining the amount by which the fair market value of the stock exceeds the option price on the date in question where rights are transferable or are no longer at risk of forfeiture. Determining these dates may be difficult and substantiating documentation supporting the date selection is important if audited. Enter your AMT calculation as an adjustment on line 14 of IRS Form 6251, Alternative Minimum Tax. Increase your AMT basis in any stock you acquire by exercising the ISO by the amount of the adjustment. Usually ISO’s are issued in groups or lots to key employees over time and are exercisable after a holding period. Your AMT basis in stock acquired through an ISO is likely to differ from your regular tax basis and is date specific. Therefore, keep adequate records for both the AMT and regular tax so that you can figure your adjusted gain or loss.

the stock in the same year you exercise the option. So the best generic advise I offer is that one reason to sell the underlying stock in the same tax year you exercise the ISO is to avoid not only AMT but the subsequent administrative burden associated with calculating the AMT liability.  Quite honestly it can be an intense exercise.  Sometimes however it makes sense based on other more weighted variables to exercise the ISO and hold the underlying stock until a future tax year.  In these years be prepared to get hit with an AMT liability paid out of pocket at tax time.  But in so doing you also are entitled to a stepped up basis which in theory should minimize capital gains liability.

Example from IRS Publication 525 – Taxable and Nontaxable Income.

Your employer, M Company, granted you an incentive stock option on April 7, 2008, to buy 100 shares of M Company at $9 a share, its fair market value at the time. You exercised the option on January 9, 2009, when the stock was selling on the open market for $14 a share. On January 26, 2010, when the stock was selling on the open market for $16 a share, your rights to the stock first became transferable. You include $700 ($1,600 value when your rights first became transferable minus $900 option price) as an adjustment on Form 6251, line 14.