Equity Compensation · 12 min read
Exercising ISOs Before an IPO: AMT Under the 2026 Rules
Exercising ISOs and holding the shares past year-end adds the spread to your alternative minimum taxable income. For 2026 the AMT exemption is $140,200 for joint filers and $90,100 for single filers, phasing out at 50 cents per dollar above $1,000,000 or $500,000, with rates of 26% and 28%. A married couple with $300,000 of wages exercising $400,000 of spread would owe about $102,000 of AMT, recoverable in later years through the minimum tax credit.
Exercising incentive stock options before an IPO is mostly a question about the alternative minimum tax. The spread is not regular income when you exercise, but it is AMT income, and for 2026 the AMT works differently than it did in 2025: the exemption now begins to phase out at $1,000,000 of AMT income for a married couple and disappears twice as fast. Many pages that rank for this question were written under the older rules. Below are the 2026 figures from the IRS and the statute, a worked calculation, how the credit comes back, the levers that change the numbers, and the California layer. Run your own numbers with a CPA before you exercise.
Why does exercising ISOs create AMT?
Because the AMT is a second tax calculation that counts the ISO spread as income in the year of exercise, while the regular tax does not. For regular tax, section 421 says no income results when you exercise a statutory option (26 U.S.C. §421(a)). For the AMT, section 56(b)(3) switches that off: the ISO is treated like a nonqualified option, so the excess of the shares’ fair market value over the strike price on the exercise date is an adjustment that increases alternative minimum taxable income (AMTI), unless you sell the shares in the same tax year (26 U.S.C. §56(b)(3)). Your AMT basis in the shares rises by the same amount, which matters later.
The AMT then runs on its own track. Starting from taxable income, it adds back the standard deduction, or state and local taxes for itemizers (26 U.S.C. §56(b)(1)), adds the ISO adjustment, subtracts an exemption, and applies 26% to the first slice of what remains and 28% to the rest (26 U.S.C. §55(b)(1)). The result is the tentative minimum tax. You pay whichever is higher: the regular tax or the tentative minimum tax. The difference, when the tentative figure is higher, is the AMT, reported on Form 6251 (IRS Instructions for Form 6251).
What are the 2026 AMT figures?
For 2026 the exemption is $140,200 for joint filers and $90,100 for single filers, and it phases out once AMTI passes $1,000,000 or $500,000 (IRS, tax year 2026 inflation adjustments). The phaseout rate is 50 cents per dollar, set by the statute as amended in 2025 (26 U.S.C. §55(d)(4)(A)(ii)), and the 28% rate starts $244,500 above the exemption (Rev. Proc. 2025-32, section 4.10). The 2025 figures, for comparison, come from the prior year’s release (IRS, tax year 2025 inflation adjustments).
| Item | 2025 | 2026 |
|---|---|---|
| Exemption, married filing jointly | $137,000 | $140,200 |
| Exemption, single | $88,100 | $90,100 |
| Phaseout begins, joint | $1,252,700 | $1,000,000 |
| Phaseout begins, single | $626,350 | $500,000 |
| Phaseout rate | 25 cents per dollar | 50 cents per dollar |
| Exemption fully gone, joint | $1,800,700 | $1,280,400 |
| Exemption fully gone, single | $978,750 | $680,200 |
| 28% rate begins (taxable excess above) | $239,100 | $244,500 |
The $1,000,000 and $500,000 thresholds are fixed for 2026 and indexed for inflation only in later years (26 U.S.C. §55(d)(4)(B)). Every other 2026 figure here comes from the IRS’s annual inflation-adjustment release.
A worked example: a married couple exercising ISOs in 2026
The couple below is hypothetical and the numbers are rounded. They file jointly, earn $300,000 of wages, take the standard deduction and have no other income. One spouse holds 20,000 vested ISOs with a $5 strike at a private company whose latest 409A value is $25 a share. They exercise all 20,000 in 2026 and hold the shares past December 31. The spread is $20 a share, or $400,000.
| Step | Amount |
|---|---|
| Wages | $300,000 |
| Standard deduction, joint, 2026 | $32,200 |
| Regular taxable income | $267,800 |
| Regular tax: $35,932 plus 24% of the $56,400 above $211,400 | $49,468 |
| ISO spread: 20,000 shares at $25 minus $5 | $400,000 |
| AMTI: taxable income, plus the standard deduction added back, plus the spread | $700,000 |
| Exemption (AMTI is below $1,000,000, so the full amount applies) | $140,200 |
| Taxable excess | $559,800 |
| Tentative minimum tax: 26% of $244,500 ($63,570) plus 28% of $315,300 ($88,284) | $151,854 |
| AMT: tentative minimum tax minus regular tax | $102,386 |
| Total federal income tax for 2026 | $151,854 |
| Cash to exercise: 20,000 shares at $5 | $100,000 |
| Cash out of pocket in the exercise year: strike plus AMT | $202,386 |
The couple pays about $102,000 of AMT on shares they cannot sell, on top of $100,000 to buy them. Nothing about the eventual sale price is known; if the company never reaches an exit, the strike price is at risk and the AMT is recoverable only slowly, through the credit described below.
The same arithmetic answers the question people actually ask, which is how much can be exercised without triggering AMT at all. With no exercise, this couple’s tentative minimum tax is 26% of $300,000 minus $140,200, or $41,548, against a regular tax of $49,468. The $7,920 gap, divided by 26%, is about $30,000 of spread: roughly 1,500 of these options in 2026 before the AMT starts. At this income level the 2026 exemption change, $3,200 higher than 2025, barely moves that answer. The phaseout change is a different story.
How does the 2026 phaseout change the answer?
For a couple whose AMTI passes $1,000,000, or a single filer past $500,000, the 2026 rules remove the exemption sooner and faster than 2025’s did. Under 2025 rules a joint filer kept the full exemption until $1,252,700 of AMTI and lost 25 cents of it per dollar above that; in 2026 the loss begins at $1,000,000 and runs at 50 cents per dollar (26 U.S.C. §55(d)(4)(A)(ii)), so the exemption is gone at $1,280,400 of AMTI rather than $1,800,700.
| AMTI | Exemption under 2025 rules | Exemption under 2026 rules |
|---|---|---|
| $800,000 | $137,000 | $140,200 |
| $1,100,000 | $137,000 | $90,200 |
| $1,300,000 | $125,175 | $0 |
| $1,600,000 | $50,175 | $0 |
Inside the phaseout band, each additional dollar of spread adds a dollar of AMTI and removes 50 cents of exemption, so $1.50 becomes subject to the 28% rate: an effective marginal AMT rate of 42%, against 35% under the old 25-cent rule. Suppose the couple above had a $900,000 spread instead of $400,000. Their AMTI would be $1,400,000 and their exemption would be zero in 2026; under the 2025 thresholds it would have been $100,175, the $137,000 exemption less 25% of the $147,300 above $1,252,700. At 28%, that lost exemption is about $28,000 of additional tentative minimum tax. For anyone weighing a large exercise, the practical point is that the band between $1,000,000 and $1,280,400 of joint AMTI is expensive, and splitting an exercise across tax years to stay below it is worth modeling.
How do you get the AMT back?
AMT paid because of an ISO exercise generates a minimum tax credit that can reduce regular tax in later years, but only in years when regular tax exceeds the tentative minimum tax (26 U.S.C. §53). The ISO adjustment is a “deferral” item, meaning it reverses over time, which is why it qualifies for the credit. The credit is figured on Form 8801 (IRS, About Form 8801), any unused amount carries forward, and it reduces tax rather than being paid out on its own.
The reversal usually happens when you sell. In the example, the couple’s regular basis is $5 a share and their AMT basis is $25 (26 U.S.C. §56(b)(3)). If they sell in a later year in a qualifying disposition at $40, the regular gain is $35 a share, or $700,000, while the AMT gain is $15 a share, or $300,000. That $400,000 difference is a negative adjustment on that year’s Form 6251, pushing tentative minimum tax well below regular tax and opening room to use the credit, up to the gap between the two (26 U.S.C. §53(c)).
Two cautions. First, the credit reduces regular tax, so if the sale year’s regular tax is modest the credit comes back over several years. Second, if the stock falls after exercise, the AMT was paid on value that no longer exists; the capital loss is limited to $3,000 a year against ordinary income (26 U.S.C. §1211(b)), and the credit still waits for years with room. That is the risk a large pre-IPO exercise carries, and the reason to size an exercise to what the household can afford to lose.
What changes the numbers
None of the approaches below is a recommendation; each is a lever to model with a CPA.
- Exercise in tranches across years. The AMT-free amount resets each January. The couple above could exercise about $30,000 of spread a year without AMT at their income; a larger annual amount can still make sense when the AMT it creates is small relative to the expected credit. Splitting also keeps AMTI out of the phaseout band.
- Exercise early in the year. An ISO sold in the same tax year as the exercise creates no AMT adjustment; the spread is taxed as ordinary income instead (26 U.S.C. §56(b)(3)). A January exercise keeps that door open until December: if the company’s value falls, or the AMT projection turns out worse than expected, a same-year sale converts the year into an NSO-like result. That only works where a sale is possible, through a tender offer, a secondary transaction or a post-IPO window, and an IPO lockup or a company trading policy can close the door; our SpaceX lockup calendar shows how staged a post-IPO release can be.
- Exercise when the 409A value is low. The adjustment is the spread, so the same options cost far less in AMT before a funding round or an IPO filing raises the 409A price. The trade is real: the money goes in earlier, and the company may not succeed.
- Exercise in a year when regular tax is already high. AMT applies only when tentative minimum tax exceeds regular tax. A year with a large bonus, an NSO exercise or an RSU vest raises regular tax and widens the room for an ISO exercise before AMT applies.
- Watch the exit window. ISO treatment requires employment until three months before exercise (26 U.S.C. §422(a)(2)), and most plans give a window of about 90 days after departure, so leaving forces the timing. Our explainer on ISOs versus NSOs covers the window and the $100,000 limit.
- Plan the cash and the estimated payments. AMT from an exercise is not withheld. A household whose withholding and timely estimates reach 100% of last year’s tax, or 110% if last year’s adjusted gross income exceeded $150,000, generally avoids the underpayment penalty (26 U.S.C. §6654); the rest is due with the return.
The California AMT layer
California has its own AMT at 7% of alternative minimum taxable income above an exemption (Cal. Rev. & Tax. Code §17062), and the ISO spread is an adjustment for it just as for the federal tax (FTB Publication 1004, Alternative Minimum Tax). For 2025 returns the state exemption is $123,667 for joint filers and $92,749 for single filers, phased out at 25 cents per dollar of AMTI above $463,745 and $347,808 (FTB, 2025 Instructions for Schedule P (540), line 22); the 2026 figures had not been published when this article was written.
Applied to the couple above, assuming California taxable income of $290,000 and the 2025 rate schedule, the state’s regular tax is about $19,850, in the 9.3% bracket (FTB, 2025 California tax rate schedules). Their California AMTI of $700,000 sits $236,255 above the phaseout threshold, which trims the exemption to about $64,600. Seven percent of the remaining $635,400 is about $44,480 of tentative minimum tax, so California AMT would add roughly $24,600 to the federal bill. California allows a credit for prior-year AMT in later years, claimed on form FTB 3510 (FTB, 2025 Instructions for Schedule P (540), section E). For someone who exercises after moving to Texas, California includes the AMT adjustment only to the extent the work from grant to exercise was performed in California, and a later qualifying sale by a nonresident is not taxed by the state (FTB Publication 1004, Incentive Stock Options).
How we approach an ISO exercise in a plan
We model the exercise as a two-year event, not a one-year tax bill: the AMT in the exercise year, then the credit path under the sale scenarios the household considers plausible, including the one where the shares are worth less. The exercise is then sized against cash, against the family’s concentration in the company, and against the rest of the tax picture, which is the core of our work on equity compensation and concentrated stock and for executives and employees with equity pay.
The projection runs through our tax planning process alongside the household’s CPA, whose return is the one that counts. When the sale finally comes, the gain planning connects to what to plan after a large gain, and for households whose income drops in a later year, to the 0% capital gains bracket.
Questions worth answering before you exercise
- What is the spread today, using the latest 409A value, on the options I am considering?
- What is my AMT-free room this year, given the rest of the return?
- Would this exercise push AMTI past $1,000,000 (joint) or $500,000 (single), into the phaseout band?
- Where will the cash for the strike price and the AMT come from, and what happens if the shares are never sold?
- Could I sell in the same year if I needed to, or does a lockup or trading window prevent it?
- Under which sale scenarios does the AMT credit come back, and how fast?
- If I worked in California, what share of the adjustment is California-sourced, and does the state AMT apply?
What this does not mean
Nothing here is a recommendation to exercise or not, or a view on any company’s value or IPO prospects. The worked example uses stated assumptions and round numbers; a different income, deduction profile, filing status or state changes every line. The federal figures are 2026 amounts from the IRS and the Internal Revenue Code; the California figures are for 2025 returns. Your own calculation belongs on a projection prepared with a CPA or tax counsel before the exercise, not after.
Frequently asked questions
What is the AMT exemption for 2026?
$140,200 for married couples filing jointly and $90,100 for single filers, per the IRS release for tax year 2026. The exemption begins to phase out at $1,000,000 of alternative minimum taxable income for joint filers and $500,000 for single filers, at 50 cents per dollar.
How did the 2026 AMT phaseout change from 2025?
In 2025 the exemption began to phase out at $1,252,700 for joint filers and $626,350 for single filers, at 25 cents per dollar. For 2026 the thresholds reset to $1,000,000 and $500,000 and the rate doubled to 50 cents per dollar, so the exemption disappears at $1,280,400 of AMTI for a joint filer instead of $1,800,700.
How much can I exercise without paying AMT?
It depends on your regular tax for the year. Compute your tentative minimum tax with no exercise, subtract it from your regular tax, and divide the gap by 26% (or 28% if you are already above the $244,500 band). That is the approximate spread you can exercise AMT-free. For a couple with $300,000 of wages and the standard deduction, it is about $30,000 of spread in 2026.
Do I get the AMT back?
Usually, over time. AMT from an ISO exercise creates a minimum tax credit, figured on Form 8801, that reduces regular tax in later years when regular tax exceeds tentative minimum tax. Selling the shares typically opens that room because the AMT basis is higher than the regular basis. If the stock falls, recovery can take years.
Does selling ISO shares in the same year avoid AMT?
Yes. If you sell in the same tax year as the exercise, there is no AMT adjustment; the spread is taxed as ordinary income instead, as a disqualifying disposition. The sale has to be possible, which a private company, a lockup or a trading window may prevent.
Does California have an AMT on ISOs?
Yes. California applies a 7% AMT to alternative minimum taxable income above its own exemption, $123,667 for joint filers on 2025 returns, and the ISO spread is an adjustment on Schedule P. The state allows a credit for prior-year AMT. For a nonresident, only the California-sourced share of the spread counts.
Sources and further reading
- IRS, tax inflation adjustments for tax year 2026, including amendments from the One Big Beautiful Bill (Rev. Proc. 2025-32)
- Rev. Proc. 2025-32, sections 4.01, 4.10 and 4.14: 2026 rate tables, AMT exemption and 28% threshold, standard deduction
- IRS, tax inflation adjustments for tax year 2025 (Rev. Proc. 2024-40)
- IRS Instructions for Form 6251 (2025), line 2i and the exemption worksheet
- IRS, About Form 8801, Credit for Prior Year Minimum Tax
- 26 U.S.C. 55, alternative minimum tax: rates, exemption and phaseout as amended by Pub. L. 119-21
- 26 U.S.C. 56(b), adjustments for individuals, including incentive stock options
- 26 U.S.C. 53, credit for prior year minimum tax liability
- 26 U.S.C. 421, general rules for statutory options
- 26 U.S.C. 422, incentive stock options
- 26 U.S.C. 1211, limitation on capital losses
- 26 U.S.C. 6654, estimated tax safe harbors
- California Franchise Tax Board, Publication 1004, Equity-Based Compensation Guidelines
- California Revenue and Taxation Code section 17062, alternative minimum tax
- California Franchise Tax Board, 2025 Instructions for Schedule P (540)
- California Franchise Tax Board, 2025 California tax rate schedules
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