Did you exercise (or are planning to exercise) an incentive stock option (“ISO”) during calendar year 2018? Do you intend to sell the underlying stock within the 12-month period from the date you exercised the ISO? If you answered yes to both of the foregoing questions, then as part of your tax planning, consider whether the underlying stock should be sold during calendar year 2018 in order to minimize your alternative minimum tax (“AMT”) exposure.
- Grant of an ISO. No tax consequence to the holder.
- Exercise of an ISO. The spread between the exercise price and the fair market value of the underlying stock (as of the date the ISO is exercised) is an item of adjustment for AMT purposes. Otherwise, there is no tax consequence to the holder at the time the ISO is exercised.
- Sale of the Underlying Stock. If the underlying stock is held throughout the holding period (i.e., for the longer of 2 years from the date the ISO was granted and 1 year from the date the ISO was exercised), then upon any sale of the underlying stock the holder would recognize long-term capital gain on the spread between the exercise price and the sale price. However, a “Disqualifying Disposition” occurs if the ISO is not held throughout the foregoing holding period. Upon a Disqualifying Disposition, the holder would recognize ordinary taxable income (and the employer would have a corresponding compensatory deduction) equal to the excess (if any) of the fair market value of the stock on the date the ISO was exercised over the exercise price. Such ordinary taxable income would be added to the stock’s basis to determine any capital gain that must be recognized on the Disqualifying Disposition.
Reducing AMT Exposure
There is no item of adjustment for AMT purposes if the ISO is exercised and sold within the same calendar year. For example, if a holder of an ISO intended to exercise the ISO on December 17, 2018, and sell the underlying stock on January 3, 2019, and the delay in selling the underlying stock was NOT for the purpose of pushing ordinary taxable income from 2018 into 2019, then the holder should consider whether it makes sense for him or her to sell the underlying stock within 2018 so as to eliminate the item of adjustment for AMT purposes. And if the purpose of selling the underlying stock in 2019 was for the holder to recognize ordinary taxable income in 2019 (and not within 2018), then the holder should at least consider the AMT consequences in his or her tax analysis.