If you work at a startup and hold incentive stock options, the alternative minimum tax is probably the most misunderstood part of your compensation package. The AMT can create a tax bill on income you haven't actually received — and the consequences can be devastating if you're not prepared.
This guide explains ISO-related federal AMT, the 2026 exemption phaseout, and how Washington’s separate taxes affect exercise and sale decisions. There is no universal pre-2028 deadline for an ISO exercise-and-hold.
In 60 seconds:
- AMT can tax the “bargain element” from an ISO exercise even if you haven’t sold the shares.
- Typical NSO compensation is included for both regular tax and AMT, so there is no separate ISO-style exercise adjustment. That does not make NSO holders immune from AMT. Employee withholding and contractor reporting differ.
- Washington’s capital-gains tax applies 7% to the first $1 million of Washington taxable capital gains and 9.9% above that amount, after applicable exclusions and deductions. The $278,000 standard deduction is the 2025 figure, not a fixed amount for later years. Beginning in 2028, separately compute Washington income tax, including the shared $1 million deduction for spouses and registered domestic partners, the §302 capital-gain adjustments and §205 credit. Do not simply add both headline state rates.
- Planning levers: stagger exercises, manage AMT credit, and plan liquidity for tax payments so you’re not forced into a bad sale.
What Is the Alternative Minimum Tax?
The AMT is a parallel tax system that runs alongside the regular federal income tax. Every year, you effectively calculate your taxes two ways — the regular way and the AMT way — and you pay whichever is higher.
The AMT was originally designed to prevent wealthy taxpayers from using deductions and credits to reduce their tax bills to zero. But because of how it treats stock options, the AMT routinely catches startup employees who aren't wealthy at all — they just happen to be sitting on paper gains they can't sell.
Here's how the AMT calculation works:
- Start with your regular taxable income.
- Apply the adjustments and preferences on Form 6251, including the standard-deduction addback where applicable and the ISO adjustment for shares held beyond the exercise year.
- Subtract the AMT exemption amount.
- Calculate tentative minimum tax using the applicable 26%/28% brackets, preferential capital-gain computation where required, and AMT foreign tax credit.
- If the result is higher than your regular tax, you pay the difference as AMT.
AMT Exemption Amounts and Rates for 2026
The One Big Beautiful Bill Act (OBBBA), signed into law in 2025, made permanent the higher AMT exemption amounts that had been temporary under the Tax Cuts and Jobs Act. But it also made the phase-out rules significantly more aggressive starting in 2026.
2026 AMT exemption amounts:
- Single filers: $90,100
- Married filing jointly: $140,200
AMT tax rates:
- For 2026, 26% applies to the first $244,500 of taxable excess after the AMT exemption ($122,250 for married filing separately), subject to the preferential capital-gain rules.
- The 28% rate applies above that taxable-excess threshold. These are not brackets applied to pre-exemption AMTI.
The new phase-out rules (this is the big change):
Starting in 2026, the AMT exemption phases out at 50 cents per dollar of alternative minimum taxable income (AMTI) above $500,000 (single) or $1,000,000 (joint). Before 2026, the phase-out rate was 25 cents per dollar.
What this means in practice: if you're a single filer and your AMTI hits $680,200, your exemption is completely gone. For joint filers, the exemption disappears at $1,280,400.
Within the phaseout range, an additional dollar of ordinary AMTI can increase tentative minimum tax by 42 cents: 28% on that dollar plus 28% on the 50-cent exemption reduction. This is a marginal tentative-minimum-tax effect, not a flat 42% tax on the entire exercise spread.
How Stock Options Trigger the AMT
Award type, exercise and sale dates, vesting, elections and the rest of the tax return determine the AMT result.
NSOs: No Separate ISO-Style Adjustment
For a typical NSO exercised into vested shares, compensation equals FMV minus strike price and is included for both regular tax and AMT. Employees generally receive W-2 reporting; contractor reporting differs. There is no separate ISO-style adjustment, but this income can still affect AMTI and exemption phaseout. Unvested shares require separate §83 analysis.
ISOs: The AMT Trigger
For a qualifying ISO exercise into vested shares held past the end of the exercise year, distinguish regular tax from AMT:
For regular tax: Nothing. You don't recognize any income at exercise. The idea is that you'll get long-term capital gains treatment when you eventually sell — as long as you meet the ISO holding periods (more than two years from grant date and more than one year from exercise date).
For AMT, the exercise spread generally becomes an adjustment under Form 6251 line 2i. A sale in the same calendar year generally eliminates that separate exercise adjustment; a later-year sale does not erase it. Unvested-share transfers and §83(b) elections require separate timing analysis.
This creates the classic ISO trap: you owe tax on a gain you haven't realized in cash. If the stock is at a private company, you can't even sell it to pay the tax.
A Worked Example
Assume a single filer under age 65 has $250,000 of 2026 wage income, takes the $16,100 standard deduction, and has no other income, deductions, credits or AMT adjustments. The employee exercises 50,000 ISOs into vested shares at a $2 strike and $12 FMV, holding them through year-end: $100,000 exercise cost and $500,000 ISO spread.
Regular taxable income is $250,000 − $16,100 = $233,900. Under the 2026 single-filer table, regular income tax is $41,024 + 32% × ($233,900 − $201,775) = $51,304. See Rev. Proc. 2025-32, §§4.01, 4.10 and 4.14.
AMTI is $233,900 taxable income + $16,100 standard-deduction addback + $500,000 ISO adjustment = $750,000.
Exemption: $90,100 — but you're above the $500,000 phase-out threshold, so the exemption is reduced by 50% of ($750,000 - $500,000) = $125,000. Since that exceeds the $90,100 exemption, your exemption is zero.
AMT taxable amount: $750,000. AMT: $244,500 × 26% + $505,500 × 28% = $63,570 + $141,540 = $205,110. Tentative minimum tax: $205,110.
Tentative minimum tax of $205,110 exceeds regular tax of $51,304 by $153,806. Under these assumptions, total regular income tax plus AMT is $205,110, before employment taxes and any payments already made.
The incremental federal income tax from this exercise-and-hold is $153,806 under the stated facts, in addition to the $100,000 exercise price. Estimated-tax or withholding adjustments may be needed during the year; do not assume every payment can wait until April.
The AMT Credit: Getting Your Money Back (Eventually)
AMT attributable to ISO deferral items can generate a minimum-tax credit under §53 and Form 8801. Not every AMT dollar generates a credit: exclusion items are treated differently. Unused eligible credit carries forward, but neither the timing nor full recovery is guaranteed.
Here's how it works:
In future years where your regular tax exceeds your tentative minimum tax (i.e., years where you wouldn't owe AMT), you can use the credit to reduce your regular tax bill. The credit can bring your tax down to — but not below — the tentative minimum tax for that year.
When do you typically recover the credit?
- A later stock sale can produce different regular-tax and AMT gain because the bases differ. Whether this permits credit use depends on the entire return.
- A lower-income year helps only if it leaves sufficient regular tax above tentative minimum tax. Lower income alone does not guarantee recovery.
- Use eligible credit over later years when the §53 limitation permits; no fixed recovery schedule applies.
The catch is that recovery can take years. In the meantime, you've paid real cash to the IRS on unrealized gains. If the stock price drops between exercise and sale, you may have paid AMT on gains that no longer exist — and your credit recovery timeline stretches even longer.
Five Strategies to Manage ISO AMT Exposure
1. Limit Your Annual Exercise Amount
The simplest strategy: don't exercise all your ISOs at once. Instead, calculate how many shares you can exercise each year without triggering AMT (or without triggering significant AMT).
The key number is your AMT “crossover point” — the exercise spread at which your tentative minimum tax first exceeds your regular tax. For a single filer with $250,000 of regular income, the $90,100 exemption stays fully intact until AMTI reaches the $500,000 phase-out threshold (roughly $250,000 of spread); above that, the exemption erodes and your effective rate climbs. But AMT itself can begin to bite at a much smaller spread, as soon as tentative minimum tax overtakes regular tax. The exact crossover depends on your bracket, so model it on Form 6251 before you exercise.
Spreading exercises across tax years can reduce exposure, but changing income and share value may defeat the plan. Separate quarters within one tax year do not create separate annual exemptions.
2. Same-Year Exercise and Sale (Disqualifying Disposition)
A same-calendar-year ISO sale is a disqualifying disposition and generally removes the separate exercise AMT adjustment. Compensation is ordinarily the exercise spread, limited under §422(c)(2) for qualifying loss-recognition sales below exercise-date FMV. Additional gain can be capital gain; not every dollar of proceeds is wages.
This strategy makes sense when:
- The stock is publicly traded and you want to lock in gains.
- You're concerned about a stock price decline.
- The AMT cost of holding would exceed the benefit of long-term capital gains rates.
Compare the compensation portion, any capital gain or loss, AMT, liquidity and total taxes. Same-year sale avoids the separate exercise adjustment but does not eliminate tax or guarantee a better overall result.
3. Early Exercise + 83(b) Election
An early exercise transfers unvested shares only if the plan permits it. A timely §83(b) election measures the transfer-date FMV minus the amount paid; zero spread must be established, not assumed from the grant date. For NSOs it generally fixes §83 compensation at transfer. For ISOs its relevant effect is generally on AMT; it does not override ISO disposition rules. File within 30 days after the actual share transfer, subject to applicable statutory deadline rules. See the §83(b) guide.
Early exercise can reduce the spread exposed to later §83 or AMT inclusion when the election is effective. Future sale treatment still depends on holding periods and ISO disposition rules. It requires:
- A company that permits early exercise.
- Cash to pay the exercise price.
- Capacity to bear loss, plus review of the repurchase terms. Unvested shares are often repurchased at cost; losing employment does not universally mean losing the entire exercise price. A forfeiture does not refund tax on compensation previously elected under §83(b).
4. Model the OBBBA Exemption Phaseout
The 2026 single-filer exemption phases out by 50 cents per dollar of AMTI above $500,000. This increases the marginal rate within the phaseout band; it is not a discontinuous tax cliff.
If pre-exercise AMTI is $400,000, another $100,000 of ISO adjustment reaches the $500,000 phaseout threshold. AMT may already be owed below that point. With $200,000 of adjustment, AMTI is $600,000 and the exemption is reduced by $50,000; only the relevant marginal dollars receive the phaseout effect.
Year-end planning is critical: if your income varies, exercise more in lower-income years and less in higher-income years.
5. Separate the Washington Exercise and Sale Decisions
The Washington planning question is when taxable compensation or sale gain is recognized.
Washington’s income tax begins January 1, 2028. A qualifying ISO exercise-and-hold generally creates no ordinary income in federal AGI, including after 2027; federal AMT can still apply.
Washington has no separate individual AMT. The federal ISO adjustment alone does not enter Washington’s AGI-based income-tax base. A later disqualifying sale or other taxable event needs its own analysis.
Beginning in 2028, taxable NSO compensation or ISO disqualifying-disposition compensation can enter the Washington base. Apply residency, sourcing, state adjustments and deductions; spouses and registered domestic partners share one $1 million deduction.
An ISO exercised in 2027 but sold in a disqualifying disposition in 2028 can produce 2028 compensation. Exercising before the state tax starts does not shelter a later taxable sale. An exercise and disqualifying sale both completed in 2027 generally recognize compensation before the new income tax begins.
Model both dates. Do not exercise merely to beat a supposed universal 2027 ISO deadline; compare liquidity, federal AMT, statutory holding periods and Washington taxes under the actual recognition years.
Washington State's Capital Gains Tax and Post-Exercise Shares
After exercise, a sale, dividend or other event can have tax consequences. An exercise-and-hold does not necessarily produce AMT in every return.
If you've met the ISO holding periods, the gain is long-term capital gains. At the federal level, that's 0%, 15%, or 20% depending on your income (plus the 3.8% net investment income tax for high earners).
In Washington, long-term capital gains above the 2025 standard deduction of $278,000 are subject to the state's capital gains tax:
- 7% on the first $1,000,000 of taxable gain (after the $278,000 deduction)
- 9.9% on taxable gain above $1,000,000 (total gains above $1,278,000)
So the combined federal-plus-state rate on a large ISO qualifying disposition in Washington could be as high as 20% + 3.8% + 9.9% = 33.7%.
Compare that to a disqualifying disposition done before 2028 (where the spread is ordinary income with no state tax): 37% federal + 0% state = 37%.
These headline rates are illustrations, not a universal ranking. Actual tax depends on brackets, sale gain, ISO compensation, AMT credit use and Washington deductions and credits. For 2028 and later, long-term gains also require the §302 base/addback and §205 credit analysis in the Washington income-tax guide.
The QSBS Wildcard
The issuer must be an eligible domestic C corporation satisfying original-issuance, active-business, redemption and other requirements. For stock issued after July 4, 2025, the gross-assets ceiling is $75 million, indexed after 2026; the earlier ceiling is $50 million. Apply the statutory historical and immediately-after-issuance tests, including issuance proceeds; company valuation is not the asset test. See the QSBS guide. Qualifying stock acquired after July 4, 2025 can receive a 50%, 75% or 100% exclusion after at least three, four or five years. Stock acquired on or before that date generally requires more than five years, with acquisition-vintage rules determining the percentage. The eligible-gain ceiling is the greater of the remaining applicable dollar limit ($10 million for the earlier regime; $15 million for the later regime, indexed after 2026) or ten times qualifying original-issuance basis for shares sold that year. This is a gain limit, not a dollar-for-dollar tax saving. Acquisition dates account for statutory holding-period rules; they are distinct from issuance dates.
Under current Washington law, the QSBS exclusion also eliminates the state capital gains tax on the excluded gain.
This creates a scenario where:
- You exercise ISOs and pay AMT on the spread.
- Hold the shares for the ISO periods and the applicable §1202 acquisition-regime period; the later regime allows partial exclusions at three and four years.
- Apply the permitted exclusion to eligible gain within the per-issuer limit. Tax on any remaining gain needs a separate calculation.
- Use eligible AMT credit against regular tax only when the §53 limitation permits.
A QSBS exclusion does not guarantee AMT-credit recovery. An excluded sale may generate little or no regular tax to absorb the credit. Model other income, regular and AMT bases, and the applicable credit limitation before treating exercise-year AMT as temporary.
The Private Company Problem
All of these strategies assume some degree of liquidity. For employees at private companies, the AMT creates an especially painful problem: you owe cash tax on paper gains you can't monetize.
Some options if you're stuck:
- Partial exercises. Exercise only what you can afford to pay AMT on.
- Company-sponsored liquidity. Some companies offer tender offers or secondary sale windows. If yours does, time your exercises to coincide.
- Borrowing against shares. Some lenders will loan against private company stock. This is risky and expensive, but it exists.
- The option agreement and plan set contractual expiration; 90 days is a common convention, not a universal rule. Separately, §422(a)(2) generally requires exercise within three calendar months after employment ends to retain ISO treatment. Ninety days does not always fit within three calendar months. The statutory disability rule extends the period to one year; §421(c)(1)(A) provides the estate/heir exception. Later exercise, if contractually permitted, generally receives NSO treatment. An extension must be reviewed for authorization and modification consequences.
The 2026 AMT Planning Checklist for Washington Residents
If you hold ISOs at a startup and live in Washington, here's what to do:
Now through December 31, 2027 (before WA income tax):
- Calculate your AMT crossover point. Use IRS Form 6251 or an AMT calculator to determine how much ISO spread you can absorb before triggering AMT. Factor in the new 2026 phase-out rules.
- Model exercises across tax years using projected income, share values, vesting and expiration dates. Do not assume the exemption will remain fully available.
- Consider early exercise and a timely §83(b) election under the actual award terms; confirm transfer-date spread and distinguish NSO compensation from ISO AMT.
- The issuer must be an eligible domestic C corporation satisfying original-issuance, active-business, redemption and other requirements. For stock issued after July 4, 2025, the gross-assets ceiling is $75 million, indexed after 2026; the earlier ceiling is $50 million. Apply the statutory historical and immediately-after-issuance tests, including issuance proceeds; company valuation is not the asset test. See the QSBS guide. Apply the correct acquisition-regime holding period.
- Compare pre-2028 taxable recognition with later recognition. A 2027 exercise does not automatically exclude compensation recognized on a later disqualifying sale.
Starting January 1, 2028 (after WA income tax):
- Model disqualifying-disposition compensation under the Washington base, shared deduction, residency and sourcing rules. Do not apply 9.9% to all sale proceeds.
- Compare exercise-and-hold with a permitted sale using both state taxes, the §302 adjustments and §205 credit, federal tax, AMT-credit limits and liquidity.
- Monitor the Washington QSBS landscape. There have been legislative attempts to subject QSBS gains to Washington's capital gains tax. If the law changes, the planning framework changes with it.
Key Takeaways
The AMT is the tax that punishes you for doing the thing ISOs are supposed to encourage — exercising early and holding for long-term gains. The 2026 OBBBA changes make it worse for higher-income filers by doubling the exemption phase-out rate.
Before 2028, Washington’s new income tax is not in effect. After it begins, a qualifying ISO exercise-and-hold still generally produces no ordinary income in federal AGI. Taxable compensation and later sales must be modeled separately.
The right strategy depends on your specific numbers — your income, your option spread, your company's QSBS eligibility, and your liquidity timeline. The framework above gives you the tools to run the analysis. But given the amounts involved, this is one area where working with a tax advisor who understands both the AMT and Washington's new tax structure is worth the investment.
Joe Wallin is a startup attorney at Carney Badley Spellman in Seattle. He advises founders, investors, and employees on equity compensation, QSBS, and Washington state tax planning. For more on equity compensation, visit the equity compensation resource page.
Related Reading
- Washington State Tax Planning Guide for High Earners
- Washington State Tax Calculator
- The Complete Guide to QSBS & Section 1202
- QSBS, Section 1202 & Section 1045
- Washington State Taxes
Related Reading
This post is for educational purposes only and is not legal or tax advice. Consult a qualified attorney about your specific situation.
