Alternative Minimum Tax (AMT)

A parallel tax system that adds back certain deductions and preferences to ensure high earners and people who exercise incentive stock options pay at least a minimum level of federal tax.

The Alternative Minimum Tax (AMT) is a parallel federal income tax system that runs alongside the regular income tax, originally designed to prevent high-income individuals from using deductions and credits to eliminate their tax liability entirely. You calculate your tax liability under both systems and pay whichever is higher. The AMT uses a different, broader definition of income — adding back certain items ('preferences' and 'adjustments') that reduce regular taxable income — and applies two flat rates (26% and 28%) rather than the progressive brackets of regular income tax. For most middle-income workers, the AMT has little practical effect; its primary real-world impact hits people who exercise incentive stock options (ISOs) in large amounts.

The AMT calculation starts with regular taxable income and then adds back specific items: the spread on ISO exercise (the difference between fair market value and exercise price at the time of exercise), state and local income taxes deducted under regular tax (SALT), certain accelerated depreciation deductions, and various other tax preference items. This 'AMT income' (AMTI) is reduced by the AMT exemption — a fixed dollar amount that phases out at higher income levels — and then taxed at 26% on AMTI up to a threshold (approximately $232,600 for single filers in 2024), and 28% above that. If AMT exceeds regular tax, you pay the difference as AMT.

ISO exercise is the most common AMT trigger for employees. When you exercise ISOs, nothing is counted as income for regular tax purposes — you only pay regular income tax when you sell the shares. But for AMT purposes, the entire spread at exercise (fair market value minus strike price) is added to your AMTI. If you exercise a large ISO grant in a single year, this addition can be enormous. An employee who exercises 100,000 ISOs with a $1 strike price when the company's fair market value is $20/share creates $1.9M of AMT income from that single event — which can generate hundreds of thousands of dollars in AMT liability even if the shares haven't been sold and no cash has been received.

The Tax Cuts and Jobs Act of 2017 significantly increased the AMT exemption and the phase-out thresholds, removing most middle-income taxpayers from AMT exposure. In 2024, the AMT exemption is $85,700 for single filers and $133,300 for married filing jointly, phasing out above $609,350 and $1,218,700, respectively. As a result, AMT now primarily affects: people exercising large ISO grants, very high-income individuals with significant state tax deductions and other preferences, and certain business owners with specific depreciation strategies. If you're considering a large ISO exercise, AMT modeling is an essential step before the exercise decision.

ISO Exercise and AMT: The Critical Risk

  • Exercising ISOs generates no regular income tax at the time of exercise — but the spread (FMV minus strike price) is an AMT preference item added to AMTI.
  • If you exercise early in the year when FMV is low, the spread is smaller and AMT exposure is lower — many employees exercise in January for this reason.
  • If the company's stock price falls after ISO exercise but before sale (common in down rounds or company failures), you can owe AMT on 'phantom income' — income from a paper gain that later evaporated.
  • The 2000 dot-com bust created thousands of AMT disasters: employees exercised ISOs at high valuations, the stocks collapsed, they owed AMT on the peak-value spread but the shares were worth far less or nothing.
  • 83(b) elections don't help with ISO AMT — the election affects when regular tax is paid on unvested shares, but ISOs exercised for vested shares are governed by different rules.
  • The AMT credit: AMT paid in one year creates a credit (Form 8801) that can reduce regular tax in future years when regular tax exceeds AMT — meaning AMT on ISOs isn't necessarily permanently lost if the shares recover in value.

How to Model AMT Exposure

  • Calculate your AMTI: start with regular taxable income, add back ISO spread, SALT deduction, and any other AMT preferences.
  • Apply the AMT exemption: subtract $85,700 (single) or $133,300 (MFJ) — reduced by 25 cents for every dollar of AMTI above the phase-out threshold.
  • Apply AMT rates: 26% on AMTI up to $232,600; 28% above that threshold.
  • Compare to regular tax: if AMT > regular tax, the difference is your AMT liability.
  • Before any significant ISO exercise, run both calculations with the proposed exercise size to quantify AMT exposure — or consult a CPA familiar with stock option taxation.
  • Spread exercises across years: exercising ISOs in multiple calendar years spreads the AMT preference and keeps AMTI in lower ranges each year.

Who Faces AMT in Practice

  • Employees exercising ISOs with large spreads — the primary real-world AMT trigger for most startup and tech employees.
  • Very high earners with large SALT deductions and other preferences — more common in high-tax states before the TCJA capped SALT at $10,000 (the TCJA SALT cap largely eliminated this for many taxpayers).
  • Business owners with significant accelerated depreciation or other preference items.
  • Most W-2 employees without ISOs: post-TCJA, the increased exemption means AMT is not a concern for the majority of workers.
  • If your employer grants ISOs rather than NSOs: ask your HR or equity administrator whether the company tracks ISO exercises for AMT purposes and whether they have resources (or CPA referrals) to help employees model AMT exposure before exercise.

Example

An engineer holds 200,000 ISOs with a $0.50 strike price. The company's current 409A fair market value is $8.00/share. She's considering exercising all 200,000 shares. The ISO spread: (8.00 − 0.50) × 200,000 = $1,500,000. This $1.5M is an AMT preference item added to her AMTI. With a salary of $200,000, her AMTI is approximately $1.7M. AMT on $1.7M (after exemption phase-out): approximately $400,000+. Her regular income tax for the year: roughly $52,000. She would owe approximately $350,000 in AMT — for shares she hasn't sold and may never sell if the company doesn't exit. Instead, she models exercising in tranches over 2-3 years, or considers exercising only the number of shares that generates ISO spread below the AMT exemption threshold.