November 30, 2009
In general, when you buy stock by exercising an incentive stock option (ISO) and don’t sell that stock in the same year, you could be subject to AMT. For regular tax purposes, no income is recognized when an ISO is exercised. However, additional income is recognized for AMT purposes equal to the excess of the stock’s FMV on the date of exercise over the exercise price. Therefore, you may be taxed on income you haven’t even received (phantom income).

Don’t be caught off guard and end up with an unexpected income tax liability when you go to file your tax return. If you exercised an ISO early in the year and the stock has been rapidly declining ever since, consider selling the stock before the end of the year. There is no AMT adjustment when stock that was acquired by exercising an ISO is sold in the same year, so you can avoid paying tax on phantom income. Otherwise, if you want to hold onto the stock and don’t want a big tax liability at year-end, you can make estimated tax payments. Also, the additional tax triggered by the AMT adjustment for ISOs generates a minimum tax credit (MTC) that may reduce your regular tax in future years.

Note: If you owed AMT attributable to the exercise of ISOs for 2007 or any prior year, the amount still owed as of October 3, 2008, was abated. However, your MTC must be reduced accordingly. In addition, any unpaid interest and penalties with respect to such unpaid AMT as of October 3, 2008, were abated. If you already paid such interest and penalties, you can increase your MTC. You should have received a Letter 2719C from the IRS detailing the amount of tax, interest, and penalties that were abated.
Topic: Advice