Sometimes, for some insane reason, people don’t like paying taxes, and that’s why we have the Alternative Minimum Tax. Created during the late 1960s with the idea of closing tax loopholes for the well-off, the AMT has begun to snag everyone from the upper middle class to the rich who don’t actually believe they really have any money at all. This holds particularly true for CEOs and key employees who receive stock options in the form of ISOs. It’s important to note, however, that just like most things related to the US tax code, there are a plethora of tax strategies and loopholes that can help circumvent or ease the burden of AMT. In this article, we’ll break down how AMT works, why it is the way it is, and 6 tried and true methods for navigating and reducing it. Let’s break it all down below.
What is the Alternative Minimum Tax (AMT)?
The Alternative Minimum Tax is a second way that the IRS uses to make sure that you have been paying taxes. Fundamentally, it’s another way to calculate how much tax you owe. It takes away some deductions and adds things back in, such as stock option gains, even if you haven’t sold anything yet. If their number is higher than your regular tax number, you have to pay the higher amount. The tax is aimed at high earners with a particular focus on people with big stock options or large capital gains in a year. You can plan around it, but for those high earners who aren’t prepared, it can hit hard.
Why does the AMT exist?
The AMT was created in 1969 after Congress discovered that 155 high-income households paid zero federal income tax due to excessive deductions and loopholes. Sounds. To fix this, lawmakers introduced a separate tax calculation to ensure that wealthy individuals still paid a minimum amount, no matter how many write-offs they used. Over time, inflation pulled more middle- and upper-middle-class earners into its scope, especially those with stock options or large capital gains, until adjustments were made in the 2017 tax reform. The 2017 Tax Cuts and Jobs Act (TCJA) significantly reduced the chances that a taxpayer would be subject to the AMT, but tax rules revert to pre-2017 conditions starting in 2026
Let’s face it, the tax not being paid by top earners is a conversation being had now, in 2025. The alternative minimum tax was an early attempt by the government to rectify that. And every year, as you can see by the chart below, it continues to climb.
Incentive Stock Options and the Alternative Minimum Tax
Incentive Stock Options (ISOs) let employees buy company stock at a fixed price that the stock is worth later. If you’ve ever traded options before, you might be familiar with this, and in the world of options, it’s called a strike price. You fix a price now, regardless of what that stock is worth later. Incentive Stock Options (ISOs) can offer significant upside, especially when the exercise price is far below the current stock value. But that spread comes at a cost under the Alternative Minimum Tax (AMT).
When ISOS are exercised and if the exerciser holds the shares, the IRS counts this “bargain element,” which is the difference between the exercise price and fair market value, as income for AMT purposes only. \ This phantom income doesn’t show up on a regular tax return, but it can trigger a substantial AMT bill, especially for high earners with concentrated equity exposure.
Example: AMT adjustment calculation on 5,000 worth of stock options
| Variable | Amount |
|---|---|
| Number of ISOs exercised | 5,000 |
| Exercise price (per share) | $20 |
| Fair market value at exercise | $60 |
| Bargain element per share | $40 |
| Total AMT adjustment | $200,000 |
Unqualified disposition vs. qualified disposition
Now, when you sell the ISO matters, and it matters a lot when it comes to how AMT sees your tax. This revolves around something the IRS calls a qualified disposition vs. an unqualified disposition, and it covers all assets, not just stock options. A qualified disposition happens when someone holds their ISO shares for at least 1 year after exercising and 2 years after the grant date. This will result in lower CGT on the sale, as you’ve held the asset. An unqualified (or disqualifying) disposition is when they sell too soon, and the gain is taxed at regular income. For example, if someone exercises ISOs in January and sells the stock that same year in June, that’s an unqualified disposition and triggers higher taxes. If you’ve invested in real estate before, the concept is the same. If you sell too soon, you’ll be charged regular income tax on your gains, whereas if you hold the asset, you are charged CGT.
How are ISOs taxed when exercised?
ISOs are taxed based on whether the shares are sold immediately or held, and how long they’re held. Timing and tax classification (ordinary income vs. capital gains) play a major role in the outcome.
Here’s a side-by-side comparison of how different ISO decisions affect taxation:
| Action | What Happens | Tax Consequence |
|---|---|---|
| Exercise and sell immediately | Shares are sold on the same day they are exercised | Taxed as ordinary income; no AMT triggered |
| Exercise and hold | Shares are exercised and held beyond the calendar year | Bargain element treated as income under AMT |
| Sell after 1 year (qualifying disposition) | Shares are held for at least 1 year after exercise and 2 years after grant | Gain is taxed as long-term capital gains |
| Sell before 1 year (disqualifying disposition) | Shares are sold before the qualifying holding period | Part of the gain is taxed as ordinary income; the remaining is taxed as capital gain |
Obviously, this all takes place in the future, so as long as you plan properly, you should be ok.
What is the AMT exemption for 2025?
The AMT exemption for 2025 is as follows:
| Filing Status | Exemption Amount | Phaseout Threshold |
|---|---|---|
| Single or Head of Household | $88,100 | $626,350 |
| Married Filing Separately | $68,500 | $626,350 |
| Married Filing Jointly | $137,000 | $1,252,700 |
Once your Alternative Minimum Taxable Income (AMTI) exceeds the phaseout threshold, the exemption shrinks by $1 for every $4 over the threshold
Beyond the exemption, AMT income is taxed at 26% up to:
-
$239,100 (or $119,550 if filing separately), and 28% on anything above that
How does AMT carry forward?
If someone pays extra tax with AMT vs. what they owe, then the IRS gives them a tax credit that they can use in the future. However, unlike other carry forward principles, such as those of losses, it only applies when the regular tax liablity is higher than AMT.
Six ways to reduce or avoid AMT from ISOs
1. Exercise ISOs early in the year
Exercising ISOs in January gives you much more wiggle room over the course of a year. It starts the clock for a qualifying disposition early and gives time to watch how the stock performs before taxes are due. If the stock ends up plummeting or falls in the same year, creating a disqualifying disposition, then you might be able to avoid AMT entirely. If the stock performs well, holding until the following January could qualify you for long-term capital gains.
The strategy opens up a wealth of options to plan how you are going to make use of your cash. For example, someone who exercised in January 2023 could sell for just after a year in 2024 in January 24 after one year, to lock in favorable tax treatment. They could theoretically use the proceeds to pay the AMT triggered the year before.
The table below outlines how this sequence might play out:
Example: ISO exercised in January, sold the next year
| Action | Date | Tax Impact |
|---|---|---|
| Exercise ISOs | January 2023 | Triggers AMT in 2023 |
| Hold shares | All year | Meets 1-year holding rule for capital gains |
| Sell shares | January 2024 | Qualifies for long-term capital gains |
2. Exercise when the spread is low
When the spread is low, meaning the distance between the exercise price and the fair market value is negligible, this isn’t exactly good news for the investor. That being said, they can take advantage of it from an AMT perspective. If the stock hasn’t appreciated much, or has even taken a temporary dip. Exercising during that low spread window can reduce or even eliminate AMT exposure.
This can be extremely helpful for employees at start-ups or pre-IPO companies where valuations are in a constant flux. The table below shows how dramatically the AMT impact can vary based on timing:
Example: Comparing low vs. high spread scenarios
| Scenario | Exercise Price | FMV at Exercise | AMT Adjustment | Likely AMT Impact |
|---|---|---|---|---|
| Small spread | $10 | $12 | $2 per share | Low or none |
| Large spread | $10 | $50 | $40 per share | High |
3. Watch the AMT phase-out range
The AMT exemption starts to phase out once income crosses a certain threshold. For every $4 over the limit, $1 of exemption disappears. That might not sound dramatic, but it adds up fast. Many taxpayers end up in a hidden 32–35% effective AMT bracket even though the top AMT rate is technically only 28%.
If ISO exercise happens during a year when income already approaches these phaseout thresholds, a small amount of “phantom income” from the options can cause a big shift in liability. Taxpayers near this range should be cautious with timing and possibly consult a tax advisor or software with AMT modeling.
4. Plan around the AMT credit and carryforward
The great part of the US tax system is that you can carry forward differnet items, particularly losses. The IRS offers a Minimum Tax Credit, but it’s only usable when the regular tax in a future year exceeds AMT. You can speed up recovery by strategically choosing which ISO shares to sell. For example, selling lots with a higher AMT basis (but lower regular basis) creates the biggest spread between regular tax and AMT, unlocking more of the credit.
This is particularly helpful for executives who plan ahead and can stagger exercises and sales to optimize their AMT recovery timeline. Below is a simplified example of how this might play out over three years:
Example: AMT credit recovery over three years
| Year | AMT Paid | Regular Tax | AMT Credit Used | Carryforward Remaining |
|---|---|---|---|---|
| 2024 | $20,000 | $15,000 | $0 | $20,000 |
| 2025 | $18,000 | $22,000 | $4,000 | $16,000 |
| 2026 | $21,000 | $28,000 | $7,000 | $9,000 |
5. Sell qualifying ISOs to fund new exercises
One of the most practical AMT mitigation tactics is to sell previously exercised ISO shares that have already qualified for long-term capital gains treatment, and use those proceeds to exercise a new batch of options. This not only provides the liquidity to pay any associated AMT, but it also allows for continuous ISO planning without needing external cash.
This strategy is common for professionals at growing companies who want to take advantage of multiple ISO grants across several years. Here’s how it might look in practice:
Example: Using qualified sale proceeds to fund a new exercise
| Action | Amount | Tax Benefit |
|---|---|---|
| Sell qualified ISOs | $100,000 | Taxed at long-term capital gains rates |
| Use proceeds for new ISO exercise | $100,000 | Exercise with low spread to reduce AMT impact |
6. Exercise in a high-income year
This might sound a bit counterintuitive, but exercising ISOs during a high-income year can actually reduce the chances of triggering AMT. This is because if you are earning a lot of income, you are paying a lot of tax (thanks, progressive tax system!) and once the regular income exceeds a certain level, it many times will often exceed what the AMT would have charged to begin with.
FAQ
How can ISO taxes be reduced?
ISO taxes can be reduced just by planning, and in many cases, people can avoid ISO taxes altogether. Another trick is to exercise the options when the spread between the strike price and market value is small, which would limit the size of the AMT adjustment.
Do taxes always apply to ISO stock options?
Taxes always apply at some point, but when and how much depends on timing and actions taken. For example, if the ISOs are sold and excerized imm If ISOs are exercised and sold immediately, any gain is treated as ordinary income and reported that year. But if the shares are held for at least one year after exercise and two years from the grant date, any profit on the sale is taxed at the more favorable long-term capital gains rate. However, the AMT may still apply in the year of exercise if the shares are not sold. This means that even though regular tax may be deferred, AMT could still create a large upfront bill.
What typically triggers the AMT?
AMT is most commonly triggered by a combination of high income and large income “adjustments” that apply only to the AMT calculation. For many tech professionals, the main trigger is exercising ISOs and holding the shares into the following year. Other common triggers include significant capital gains, high state income taxes, or large itemized deductions that are added back for AMT purposes. The more adjustments present on a return, the more likely the AMT will apply.
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