Exercising an
Incentive Stock Option?
Plan to Avoid the Alternative Minimum Tax (AMT)
In general, when you buy stock by exercising an incentive stock option
(ISO) and don’t sell that stock in the same year, you could be subject to
AMT. For regular tax purposes, no income is recognized when an ISO is
exercised. However, additional income is recognized for AMT purposes equal
to the excess of the stock’s fair market value (FMV) on the date of
exercise over the exercise price. Therefore, you may be taxed on income
you haven’t even received (phantom income).
Don’t be caught off guard and end up with an unexpected tax liability when
you go to file your tax return. If you exercised an ISO early in the year
and the stock has been rapidly declining ever since, consider selling the
stock before the end of the year. There is no AMT adjustment when stock
that was acquired by exercising an ISO is sold in the same year, so you
can avoid paying tax on phantom income. Otherwise, if you want to hold
onto the stock and don’t want a big tax liability at year-end, you can
make estimated tax payments. Also, the additional tax triggered by the AMT
adjustment for ISOs generates a minimum tax credit (MTC) that may reduce
your regular tax in future years.
If you think the long-term prospects are good for the stock acquired
through an ISO exercise, but you don't have the cash on hand to cover the
AMT, you might sell just enough of the stock to generate the cash to pay
the AMT, and hold the rest of the shares for the long term.
Note: If you owed AMT attributable to the exercise of ISOs for 2007 or any
prior year, the amount still owed as of October 3, 2008, was abated.
However, your MTC must be reduced accordingly. In addition, any unpaid
interest and penalties with respect to such unpaid AMT as of October 3,
2008, were abated. If you already paid such interest and penalties, you
can increase your MTC. You should have received a Letter 2719C from the
IRS detailing the amount of tax, interest, and penalties that were abated.
