AMT
AMT is a parallel tax system designed to ensure that taxpayers with significant deductions or preference items pay a minimum amount of tax. Taxpayers compute their tax under both the regular system and the AMT system; they pay the higher of the two.
AMT was originally created to prevent high-income taxpayers from using deductions to eliminate their tax liability entirely. The Tax Cuts and Jobs Act of 2017 substantially raised AMT exemptions, dramatically reducing the share of taxpayers affected — but AMT remains a meaningful planning consideration in specific situations.
The most common AMT trigger for individuals is the exercise of incentive stock options (ISOs). The bargain element on ISO exercise (current market price minus strike price, multiplied by shares exercised) is a 'preference item' that increases AMT income but doesn't appear in regular taxable income until the shares are sold. A taxpayer who exercises a large ISO grant with a substantial bargain element can owe AMT in the year of exercise even if no sale occurs — a 'paper-gain' tax that has caused real cash-flow problems for tech employees in past years.
AMT paid in excess of regular tax becomes an AMT credit that can offset regular tax in future years (when regular tax exceeds AMT). For ISO exercise scenarios, this means the AMT paid is recoverable over time as the shares are sold and the regular-tax-vs-AMT comparison flips. Planning around ISO exercise typically involves projecting both regular tax and AMT through the year of exercise and the year(s) of sale to model the cash-flow timing.
AMT = max(0, AMTI × rate − exemption_phased) − regular_tax- AMTI
- = Alternative minimum taxable income (regular taxable income + preference items + adjustments)
- rate
- = 26% below §55(b) breakpoint (~$245k for 2026), 28% above
- exemption_phased
- = AMT exemption ($87,400 single / $135,200 MFJ for 2026), phased out at high income
- regular_tax
- = Federal income tax under regular rules (not AMT)
Synthetic households with ISO grants need full AMT modeling: bargain element on exercise, AMT preference accumulation, AMT credit carryforward, and the multi-year recovery path as shares are sold. Test scenarios should include the 'AMT cliff' case (large ISO exercise + market drop before sale, taxpayer owes AMT on phantom paper gain) and the 'AMT credit recovery' case (multi-year sales producing regular-tax-exceeds-AMT years that consume the credit).
Common pitfalls
- Computing AMT only at year-end — large ISO exercises mid-year should trigger AMT projection updates immediately to inform sell-vs-hold decisions before December 31.
- Treating the AMT credit as forgotten money — many tech employees overlook the credit balance carrying forward from prior years.
- Forgetting the §55(b) breakpoint — AMT rate is 26% below the breakpoint, 28% above; the breakpoint is indexed annually.
- Missing the disqualifying-disposition recharacterization — selling ISO shares before the holding-period requirement converts the exercise to NSO treatment and recovers some AMT but at the cost of ordinary-income classification.
Examples
Pre-IPO startup employee exercises 50,000 ISOs at $4 strike when FMV is $40. Bargain element: 50,000 × ($40 − $4) = $1,800,000. AMT preference adds $1.8M to AMT income; AMT due ~$500,000. Stock then drops to $8 before the employee can sell. Cash needed for AMT: $500K. Stock now worth: $400K. Tax owed exceeds value of the position. The AMT credit is recoverable as shares are eventually sold, but the cash-flow crisis is immediate.