top of page

Navigating AMT: How to Plan for Alternative Minimum Tax on Equity Compensation

Writer's picture: Sean RawlingsSean Rawlings

If you’ve received equity compensation like Incentive Stock Options (ISOs), you might be aware that the financial perks can come with some complicated tax consequences. One of the trickiest aspects for many is the Alternative Minimum Tax (AMT). While it’s something that not all employees with stock options face, if you do, it can catch you off guard if you're not prepared.


In this post, we’re going to break down what the AMT is, how it relates to your ISOs, and most importantly, how you can plan ahead to reduce or even avoid the unwanted tax impact. Let’s dive in.


What Is the Alternative Minimum Tax (AMT)?

The AMT was introduced years ago to make sure that people who were taking advantage of tax breaks still paid a minimum level of tax. Unlike the regular income tax system, the AMT adds back certain deductions that you might take on your normal return, requiring you to calculate your tax liability twice—and pay the higher of the two.

For those with equity compensation, particularly ISOs, the AMT can easily become an issue because of how the tax system treats the "spread"—the difference between what you paid for your stock and its fair market value at the time of exercise. And even if you haven't sold your stock, that spread can trigger an AMT liability.


How Does AMT Apply to ISOs?

ISOs are attractive because they offer potential tax benefits, such as the possibility of long-term capital gains treatment on gains if you hold the shares for the required period. However, the downside is that when you exercise ISOs, the difference between the exercise price and the current fair market value of the stock is considered income for AMT purposes.

For example, let’s say you have the right to buy stock at $20 a share, but the stock is worth $100 a share when you decide to exercise. You technically haven’t sold anything yet, so no regular income tax is due. However, under AMT rules, you must count the $80 difference per share as income, which could increase your taxable income for the year—possibly pushing you into the AMT zone.


The Impact of AMT on Your Taxes

The tricky thing about AMT is that it doesn't just apply to the income from your ISOs—it affects your entire tax return. AMT starts with your regular taxable income and then makes certain adjustments, like removing deductions that aren’t allowed under AMT rules.

If the AMT results in a higher tax liability than your normal tax calculation, then you'll have to pay the higher amount. This could leave you with a big tax bill, even though you haven’t sold any shares and don’t have the cash to cover it. This is often referred to as “phantom income,” and it can be a real headache if not managed correctly.


How to Plan for AMT with Equity Compensation

Now that we know how the AMT works and why it can impact those with ISOs, let’s talk about how to plan for it. While AMT may be unavoidable in some cases, there are strategies to help minimize its effect and make it more manageable.


1. Exercise Your ISOs Gradually

Rather than exercising all your options in one year, consider spreading out the exercises over several years. This can help keep your taxable income lower in any one year, reducing the chances of triggering the AMT. By exercising smaller amounts over time, you can better manage the tax impact.


2. Sell Some Shares in the Same Year You Exercise

One of the ways to offset the AMT burden is to sell some shares in the same year that you exercise your ISOs. By doing this, you can cover the taxes you owe from the exercise and reduce the impact of AMT. It also helps prevent you from getting caught with a big tax bill and no way to pay it if you haven’t sold any stock.


3. Offset AMT with Other Deductions or Losses

The good news is that while some deductions aren’t allowed for AMT purposes, others are. If you have other investments or business income that can generate deductions, like rental property or tax-loss harvesting, these could help reduce your taxable income and lower your AMT liability.


4. Make Estimated Tax Payments

If you know you’ll be facing a large AMT bill due to your equity compensation, consider making estimated tax payments throughout the year. This helps spread the tax burden and ensures that you aren’t hit with a large, unexpected tax bill at the end of the year.


5. Consult a Financial Planning Firm Specializing in Equity Compensation Planning

AMT can be complex, especially when paired with equity compensation. That’s why it’s so helpful to work with a financial planning firm that specializes in equity compensation planning. A firm like WealthBound Advisors can help you understand the potential AMT impact of your ISOs, create a strategy to minimize the tax burden, and ensure you’re making the best decisions for your financial future. With our expertise in this area, we can help you navigate the complexities of AMT, so you don’t have to go it alone.


Conclusion: Plan Ahead to Minimize AMT

When you have equity compensation, it’s critical to plan for potential AMT exposure. By exercising options gradually, selling shares to offset AMT income, and working with experts, you can reduce the impact of AMT and avoid surprises come tax season. A proactive approach to your equity compensation planning can not only minimize your tax burden but also help you maximize the wealth-building potential of your stock options.


If you’re feeling uncertain about AMT and how it impacts your equity compensation, don’t hesitate to reach out to WealthBound Advisors. We specialize in helping professionals like you navigate the complex world of equity compensation, tax planning, and long-term wealth management. Let’s work together to create a strategy that fits your financial goals and minimizes your tax liability.


Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax, and financial team before making any changes to your financial plan.

bottom of page