Step-by-step · 5 min read
ISOs: exercising without an AMT shock
Incentive stock options give you the right to buy company shares at a fixed price, the strike price. Handled well, they can turn years of growth into long-term capital gains. Handled badly, they can create a large tax bill on shares you cannot sell.
The difference comes down to the alternative minimum tax, the AMT. Exercising ISOs and holding the shares creates no regular income tax, but the gain on paper at exercise counts toward the AMT. Planning the size and timing of each exercise is how you keep the AMT small or avoid it altogether.
- Who it fits
- Employees of startups and public companies holding incentive stock options.
- Usually not a fit
- People with only NSOs or RSUs. See those guides instead.
- Figures
- 2026 tax year
The key rule
Exercising ISOs and holding the shares past year-end adds the spread (market value minus strike price) to your AMT income. Sell at least two years after the grant date and one year after exercise, and the whole gain is taxed as long-term capital gain.
How it works
There are three moments that matter:
- Grant. Nothing is taxed. The clock for the two-year rule starts.
- Exercise. You pay the strike price. No regular tax and no payroll tax are due. If you still hold the shares at year-end, the spread is added to your AMT income for that year. The clock for the one-year rule starts.
- Sale. If you meet both holding periods, the whole gain over the strike price is long-term capital gain. If not, it is a disqualifying disposition and part of the gain is ordinary income.
The AMT is a parallel tax calculation. You pay whichever is higher: the regular tax or the AMT. Because the AMT has a large exemption, most people have some room to exercise ISOs each year before it costs anything. For 2026 the exemption is $90,100 for single filers and $140,200 for married couples filing jointly. It shrinks by 50 cents for each dollar of AMT income above $500,000 (single) or $1,000,000 (joint).
AMT paid because of ISOs is not lost forever. It usually becomes a credit you can use in later years when your regular tax is higher than your AMT, including the year you sell the shares.
7 steps
Gather your grant details
For each grant: number of options, strike price, grant date, vesting schedule and expiration date. Your company issues a Form 3921 for every ISO exercise; keep those too. For private companies, get the latest 409A fair market value. For public companies, the market price is the value.
Find your AMT room for the year
We build your full projection: salary, bonus, other income and deductions. Then we calculate how much ISO spread you can add before the AMT exceeds your regular tax. That number is your "free" exercise room for the year.
Choose how much to exercise
Exercising up to your AMT room every year often costs far less in total than exercising everything at once. If the company is likely to grow fast, exercising a little more than the room, and paying some AMT, may still make sense to start the holding clock sooner. We will show you both.
Decide the timing within the year
Exercising early in the year starts the one-year clock sooner and gives you most of the year to watch the price. If the price falls a lot before December 31, you can sell the shares in the same year. That turns it into a disqualifying disposition and removes the AMT adjustment, so you are taxed only on the lower actual gain.
Fund the exercise and the tax
You need cash for the strike price and, if you go beyond your AMT room, for the AMT itself, due the following April (or through estimates). Do not exercise with money you might need, especially for private companies where you cannot sell.
Track the AMT credit
If you pay AMT, keep Form 6251 and Form 8801 from every year. The credit carries forward with no expiration. We use it in the years when your regular tax is higher.
Plan the sale
Once both holding periods are met, a sale is a qualifying disposition: the full gain over the strike is long-term capital gain, taxed at 0%, 15% or 20%, plus 3.8% net investment income tax at higher incomes.
Selling earlier is a disqualifying disposition. The spread at exercise (or your actual gain, if lower) becomes ordinary income, and anything above that is capital gain.
Example 1
Exercising within your AMT room
You hold 20,000 ISOs with a $2 strike. The 409A value is $12, so the spread is $10 a share. We calculate that you can add about $60,000 of spread this year without owing AMT. You exercise 6,000 options for $12,000 and owe no extra tax. Next January, you do the same again.
Example 2
Exercising everything at once
Same grant, but you exercise all 20,000 at once. You pay $40,000 to exercise and add $200,000 to AMT income. The AMT might be $30,000 to $40,000, due in April, on shares you cannot sell yet. Some of that comes back as a credit later, but only when your regular tax is higher.
Common mistakes
- Only $100,000 of ISOs, measured by the grant-date value of the shares, can first become exercisable in any calendar year. Anything above that is treated as NSOs. Check your grant agreement.
- If you leave the company, ISOs must be exercised within three months of your last day to keep ISO status. After that they are taxed as NSOs.
- Early exercise with an 83(b) election can avoid the AMT if the spread at exercise is zero. If there is a spread, it still counts.
- Selling shares in a later year at a loss does not erase AMT paid in the exercise year. It only creates a credit and a capital loss.
Key dates
- January
- Good time to exercise: the full year to decide on a same-year sale.
- Before December 31
- Last chance to sell in the same year and remove the AMT adjustment.
- January 31
- Your company sends Form 3921 for each ISO exercise.
- Two years from grant and one from exercise
- The earliest date for a qualifying sale.
Questions we hear
Does exercising ISOs show up on my W-2?
No, not for a qualifying disposition or an exercise you hold. A disqualifying sale is often added to your W-2 the year you sell, but no payroll tax applies.
Is a cashless exercise of ISOs possible?
Yes, at public companies. But selling the shares the same day is a disqualifying disposition, so the spread is taxed as ordinary income.
What if my company is acquired?
Your options may be cashed out, converted into the buyer's options or accelerated. Each has different tax results. Send us the deal documents as soon as you receive them.
What to send us
- Your option grant agreements
- The latest 409A value or share price
- Any Forms 3921 received
- Exercises already made this year
- Prior-year Form 6251 and 8801, if any
Upload them to your client portal.
General education for TaxSquad clients, not advice for your situation. Rules and figures change. Talk to us before acting on this guide.