Cap tables and equity
ISOs and AMT
Incentive stock options skip regular tax at exercise, but the spread is an AMT adjustment — and a qualifying sale needs two holding periods.
Incentive stock options are only for employees and come with statutory limits and holding-period tests. The headline benefit: no regular federal income tax at exercise. The trap: the spread is an Alternative Minimum Tax (AMT) adjustment. You may owe AMT even though you received no cash.
Recruiters may say "ISOs, which are better for you." Partially true and incomplete. ISOs can yield better sale tax treatment if you meet holding periods, but they create AMT risk at exercise and cannot be granted to non-employees. Large grants often mix ISO and NSO because of the $100k limit: only the first ~$100k of underlying FMV (at grant) that first becomes exercisable in a calendar year can be ISOs; the excess is treated as NSOs.
The big idea
Concept
AMT is a parallel tax computation with fewer preferences. ISO exercise spreads increase AMT income. If AMT exceeds regular tax, you pay the difference. You may get an AMT credit in later years — but credits are not cash when you need to write the IRS a check the April after you exercise illiquid shares.
At sale — qualifying disposition: if you sell after both 2 years from grant date and 1 year from exercise date, the entire gain over strike is generally long-term capital gain for regular tax (AMT history still matters via credits — get help).
Disqualifying disposition: sell earlier → part or all of the gain is ordinary income (roughly, ordinary on the spread at exercise or at sale depending on facts; remainder capital).
Walking through the trap
Exercise 50,000 ISOs at strike $0.50 when 409A FMV is $8.00.
Spread = 50,000 × ($8.00 − $0.50) = $375,000 AMT adjustmentDepending on filing status, other income and exemptions, AMT on a preference that large can land in the tens or low hundreds of thousands of dollars — while your shares cannot be sold on Nasdaq. People have borrowed against homes or sold under distress to pay this.
Partial exercise, exercise-and-sell in a tender, or waiting for a lower FMV / 83(b)-aware early exercise when spread is ~$0 are the usual risk controls — with an advisor running your numbers.
A cleaner path, if you can fund it: grant 2022, exercise 2025 at $2 FMV vs $0.40 strike (manageable AMT that year), sell 2027 at $20 after both holding periods. Regular tax: long-term gains on $20 − $0.40. AMT credit may reclaim earlier AMT over time. Outcome can beat NSO treatment dramatically — if you funded exercise and AMT and the company survived.
The ugly path: exercise a large ISO block at a high 409A the week after a tender was canceled. April arrives, AMT due, no buyers.
Common mistakes
- Treating "no regular tax at exercise" as tax-free. AMT is a real check.
- Missing the two holding periods. Sell early and you disqualify into ordinary income.
- Exercising the whole grant in one tax year. Tranches can spread AMT; the $100k ISO cap already splits large grants.
Check yourself
You exercise ISOs with a $200k spread and cannot sell the shares. What tax might you still owe?
AMT on that $200k adjustment, due the following April, with no sale proceeds to fund it.
An ISO grant in 2022, exercised in 2025, sold in 2025. Qualifying disposition?
No. You need 2 years from grant (that part is OK) and 1 year from exercise (you sold in the same year).
Key takeaways
- ISOs: no regular tax at exercise, but AMT on the spread.
- A qualifying sale needs 2 years from grant and 1 year from exercise.
- Only ~$100k of FMV (at grant) that first becomes exercisable per year can be ISOs.
- Model AMT before you click Exercise; partial exercise and tenders are the usual controls.
Further learning
Next, locking tax at grant: 83(b) elections.