Alternative Minimum Tax

So you exercised some ISOs this year. Congrats! But before you celebrate too hard, there’s a lurking tax wrinkle you might’ve missed: the alternative minimum tax (AMT).

It’s not a penalty. It’s not an audit trigger. If you exercise equity in a fast-growing company, it can hit you with a surprise tax bill come April.

Let’s break down what AMT is, how it works, and how startup employees can stay ahead of it.

What is AMT?

The alternative minimum tax is a parallel tax system designed to make sure high earners pay at least a baseline amount of federal income tax, no matter how many deductions or tax breaks they claim.

You calculate your taxes two ways:

1. The regular way (with all the usual deductions)
2. The AMT way (with fewer deductions and special rules)

You then pay whichever amount is higher.

For most people, AMT is a non-issue. But for startup employees who exercise incentive stock options (ISOs), especially without selling those shares in the same year, it can create unexpected “phantom income” that pushes them into AMT territory.

Why it matters for startup employees

Unlike public stock, startup equity doesn’t come with a warning label. There’s no TurboTax pop-up reminding you that exercising your ISOs could trigger an extra five-figure tax bill, even if you didn’t sell a single share.

Here’s where AMT becomes a problem:

1. You exercised ISOs and held them
2. Your company’s FMV is high
3. You didn’t plan for the tax hit

That combo can add thousands (or more) to your tax liability, catching you off guard in April.

If you're planning to exercise options in a high-upside startup, Prospect can help you estimate your likely exit value and decide if the tax hit is worth it.

How AMT works (Stripe & Anduril examples)

When you exercise ISOs, you pay a strike price, say $1 per share. But the fair market value (FMV) at the time might be $10. That $9 spread is what the IRS calls a preference item, and it’s included in your Alternative Minimum Taxable Income (AMTI).

Even if you haven’t sold, the IRS treats it as income for AMT purposes only.

Example 1: Stripe engineer
You exercise 10,000 ISOs in 2024 at $2/share when Stripe’s FMV is $20. That’s an $18 spread, or $180,000 in additional AMTI. If your regular taxable income was $150K, your AMT income is now $330K. That could trigger a five-figure tax bill, even without a sale.

Example 2: Anduril designer
You earn $170K, and your partner earns $160K. You exercise ISOs with a $100K spread but hold the shares. As a married couple filing jointly, your AMTI is now $430K. Depending on other deductions, you might cross the AMT threshold.

2024 AMT thresholds & exemptions

Once you calculate your AMTI, you subtract the AMT exemption, a fixed amount that reduces your taxable base.

2024 AMT exemptions:

Filing Status

Exemption Amount

But these exemptions start to phase out above certain income levels:

Filing Status

Phaseout Threshold

Above those thresholds, your exemption shrinks by $0.25 for every $1 you earn. Eventually, it disappears entirely.

How to calculate AMT

Here’s the general process:

1. Calculate AMTI
   
   
   
   • Start with your regular income
   • Add back deductions not allowed under AMT (like state taxes)
   • Add preference items (like income from exercising ISOs)
     
     
2. Subtract your AMT exemption: Based on your filing status
   
   
3. Apply the AMT tax rate
   
   
   
   • 26% up to $232,600 (or $116,300 if married filing separately)
   • 28% on any amount above that
     
     
4. Compare to your regular tax: You pay whichever is higher

What is an AMT credit?

If you end up paying AMT, it’s not necessarily gone forever.

You may be eligible for an AMT credit, which can offset your regular taxes in future years. The catch? You can only use it in years when your regular tax exceeds your AMT.

Think of it as a slow refund drip, reclaiming some of what you overpaid, gradually.

Common myths & mistakes

Let’s clear up a few misunderstandings we hear all the time from startup employees:

Myth: AMT means you owe taxes immediately after exercising.
Not quite. The tax isn’t due until you file your return (typically in April), but the liability is triggered in the same year you exercise ISOs. However, you may be required to make quarterly payments to the IRS ahead of April.

Mistake: Exercising all your options without estimating AMT.
This is the classic facepalm moment. Many employees think they’re being smart by exercising early, until they get a surprise $30K+ bill months later.

Myth: Selling your shares after exercise always solves the problem.
Not if you wait too long. Selling in the same calendar year you exercise avoids the AMT hit. But if you delay the sale into a subsequent year, your AMT liability, calculated at the time of exercise, may no longer match your actual gains, leaving you exposed to potentially owing AMT on income you haven't realized yet, especially if the stock value declines.

How to minimize AMT exposure

There’s no one-size-fits-all approach, but these strategies can help:

1. Use an 83(b) election (if allowed)

If your company offers early exercising, you can exercise unvested shares and file an 83(b) within 30 days. This taxes you upfront, usually when the spread is zero or tiny.

2. Exercise small batches

Instead of exercising all 20K shares, try 5K this year and see what the tax hit looks like.

3. Lower your Adjusted Gross Income

Max out your 401(k), contribute to an HSA, or donate to charity. Every dollar counts. 

However, there is no one-size-fits-all approach since minimizing AMT is complex and highly personalized. Prospect can help you model different scenarios, custom tailor your strategy, and build a plan that fits your goals.

What happens if the Tax Cuts & Jobs Act expires?

The 2017 Tax Cuts and Jobs Act (TCJA) temporarily raised AMT exemption amounts, making AMT less common for many.

If it expires in 2025 as planned, we could revert to lower exemption levels, making AMT more likely to impact startup employees.

Example:

That means AMT could suddenly become relevant to thousands more startup workers, especially in high-valuation companies.

To sum it up

• AMT is a parallel tax system that kicks in when your ISO exercise spread is big
• It can apply even if you don’t sell shares
• You pay the higher of the regular tax or AMT
• Planning matters: exercise in small batches or time it with a same-year sale
• The TCJA expiring in 2025 could bring AMT back for more employees

If you’re thinking about exercising options this year, don’t go it alone. Prospect helps you plan smarter exits, avoid AMT surprises, and make equity work in your favor.

Frequently Asked Questions