Here's a story that plays out every year somewhere in the Bay Area: an engineer exercises their ISOs at a unicorn, expecting nothing immediate. April rolls around, their accountant calls. They owe $200,000 in AMT — on shares they can't sell.
How AMT works
The Alternative Minimum Tax is a parallel federal tax system. You calculate your taxes both ways (regular and AMT) and pay whichever is higher. The trigger for most ISO holders is the 'AMT preference item': when you exercise an ISO and hold the shares, the spread between strike and fair market value becomes a preference item, increasing AMT income.
Concrete example
You're a Stripe engineer who joined in 2021. You have 5,000 ISOs at a $55 strike. The 409A is now $75 (fair market value). You exercise all 5,000 in December 2024.
- Spread: ($75 − $55) × 5,000 = $100,000
- Regular taxable income: assume $200K salary. Federal tax on that: ~$38K.
- AMT income (AMTI): $200K + $100K spread = $300K. After AMT exemption (~$87K for single): $213K AMTI. AMT rate: 26%. AMT: ~$55K.
- AMT minus regular tax: $55K − $38K = $17K additional AMT owed.
That's manageable. Now imagine you exercised 20,000 shares at the same spread: $400K AMT preference item, AMTI of $600K, AMT of $170K minus regular tax $38K = $132K additional owed.
Strategies
- Stay below the AMT phase-out: exercise enough each year that your AMT roughly equals your regular tax. Your CPA can compute the breakeven.
- Disqualifying disposition: if you sell within the year of exercise, the ISO is treated like an NSO. Spread is ordinary income, no AMT issue. You lose LTCG treatment, but you also have cash from the sale.
- AMT credit: in years where you pay AMT, you accumulate a credit you can use to offset regular tax in future years. The trap eventually unwinds — but you need the cash now.
If you're considering a large ISO exercise, model it in tax software (or hire a CPA) before December. A few thousand dollars in advice can save $50K+ in mismanaged AMT.