Generally, for each tax year you pay either your regular-tax liability or your alternative minimum tax (AMT) liability, whichever is higher. For most people, the regular-tax liability always turns out to be greater, so the AMT never comes into play. Unfortunately, however, the AMT is hitting a growing number of mere middle-income taxpayers, including people who exercise incentive stock options (ISOs) and hold the shares. This risk is especially pertinent for those who live in high-tax states, itemize tax deductions, and/or have significant personal exemptions, particularly if they exercise and hold ISOs with a big spread. To help your AMT planning, a recently updated FAQ at myStockOptions.com presents a table showing AMT trigger points across a wide range of yearly incomes. For example, if in 2013 you have regular taxable income of $200,000, all it takes to trigger the AMT is a positive adjustment (e.g. ISO spread at exercise) of only $9,163 for joint filers or $8,090 for a single filer.
Over the past several years, Congress has had to take special measures to restrain the spread of the AMT and thus keep it from unfairly taxing millions of people (see the related FAQ on recent developments). In the American Taxpayer Relief Act of 2012, Congress made three major changes in the AMT calculation but did not eliminate the AMT (see the FAQ with details of the changes).
If you are in danger of triggering the AMT, you may be interested in our FAQ that explains various ways to minimize AMT exposure. One strategy involves year-end or year-beginning exercise. Some advisors suggest exercising ISOs at the end of each year, when you can safely estimate whether you will owe AMT for that year. The idea here is to exercise ISOs up to a point at which the aggregate ISO spread will not trigger the application of AMT (i.e. to equalize your AMT and regular-tax liability). For more on this strategy, see a related FAQ on myStockOptions.com. Others advise employees to exercise ISOs in the first quarter of a year: if the stock price drops you can sell the ISO shares later during the same calendar year and avoid paying AMT on paper profits. (See a related FAQ with examples of tax treatments that may apply after a disqualifying disposition in the same year as exercise.) Alternatively, if the stock price rises, you hold the shares. By tax-return time the following year, you will have satisfied the ISO holding periods, so all your gain over the exercise price will be long-term capital gain. When you file your tax return before April of the next year, should you then sell some of the ISO stock to pay AMT, you will at least receive long-term capital gains tax treatment on the appreciation of the sold shares.