Risk of Pursuing a Qualifying Disposition of ISOs: Alternative Minimum Taxes<\/strong><\/h2>\n\n\n\nSaving taxes is great. But there\u2019s one key risk to pursuing a Qualifying Disposition strategy to be aware of: the Alternative Minimum Tax (\u201cAMT\u201d). Many people don\u2019t realize this, but when you file your taxes each year, your potential tax liability is being calculated on two parallel systems; the ordinary income tax system, and the Alternative Minimum Tax system. Whichever resulting tax liability is higher is what you pay.<\/p>\n\n\n\n
For over 90% of Americans, the tax liability calculated under the ordinary income tax system is higher than what\u2019s calculated under AMT. For that reason, few people ever have to deal with AMT. But AMT can often come into play when exercising ISOs. How?<\/p>\n\n\n\n
Under the Qualifying Disposition rules for ISOs, when you exercise the options, you must report the \u201cbargain element\u201d on your tax return. The Bargain Element is the difference between the price of the stock on the day you exercise options less the exercise price. Then you multiplied that by the number of options. <\/p>\n\n\n\n
In the example above the bargain element would = 10,000 shares x ($25 price on day of exercise – $10 exercise price) = $150,000.<\/p>\n\n\n\n
That $150,000 number is then fed into the Alternative Minimum Tax system and taxed at either 26% or 28%. If the resulting tax liability under AMT is higher than your tax liability calculated under the ordinary income tax system, then you owe the higher AMT taxes. <\/p>\n\n\n\n
What To Know About the AMT<\/h3>\n\n\n\n
This can be very problematic for the employee, as they face two \u201ccash calls\u201d from exercising ISOs if they intend to pursue a Qualified Disposition strategy:<\/strong><\/p>\n\n\n\n1) Cash needed to buy the stock; in the above example, $100,000 (10,000 shares x $10\/share exercise price).<\/p>\n\n\n\n
2) Cash needed to cover AMT tax liability when they file taxes the following year.<\/p>\n\n\n\n
Remember, when you pursue a Qualifying Disposition strategy, you cannot sell the stock before you meet both holding period requirements! That means you aren\u2019t able to sell stock to help pay any AMT tax you may owe. <\/p>\n\n\n\n
Pro Tip: If you\u2019re going to exercise ISOs and pursue a Qualifying Disposition strategy, calculate your potential Bargain Element first (Current price of stock – Exercise price x # of shares exercised). If that amount is greater than $80,000 for Single tax filers or $125,000 for Married tax filers, it\u2019s highly recommended you speak to a tax professional before you exercise any stock.<\/strong><\/p>\n\n\n\n