Incentive stock options (ISOs) offer long-term capital gain treatment on the entire gain if you meet the holding periods. The main complication is the alternative minimum tax.
How ISOs are taxed
- Grant: no tax.
- Exercise: no regular income tax, but the spread between fair market value and the exercise price is an AMT adjustment.
- Sale: if you hold at least two years from grant and one year from exercise, the whole gain is long-term capital gain. Selling earlier is a disqualifying disposition, and the spread at exercise becomes ordinary income, capped at your actual gain if you sell for less than the exercise-date value.
If you hold founder stock or ISOs, Summer Associates can review QSBS eligibility and model the tax on the exercise or sale scenarios you choose.The first consultation is free, with no obligation.
Book a free consultationThe 2026 AMT numbers
| Single | Married filing jointly | |
|---|---|---|
| AMT exemption | $90,100 | $140,200 |
| Phase-out begins | $500,000 | $1,000,000 |
| Phase-out rate | 50 cents per dollar | 50 cents per dollar |
The 2025 law reset the phase-out thresholds to $500,000 / $1,000,000 and doubled the phase-out rate to 50%. Inside the phase-out band, each extra dollar of AMT income loses 50 cents of exemption, so the effective AMT rate can reach about 42%, or 28% × 1.5.
Key numbers: AMT exemption $90,100 / $140,200 · phase-out at $500,000 / $1,000,000 · 50% phase-out rate · ISO holding periods 2 years from grant and 1 year from exercise.
Strategies
Exercising when the spread is near zero, at grant or through early exercise with an 83(b), keeps AMT minimal and starts the holding periods.
Another approach is to exercise in annual slices. Calculate your AMT crossover, the amount of spread you can add before AMT exceeds regular tax, and exercise up to it each year.
A January exercise gives you until December to decide on a disqualifying sale if the stock falls, which can unwind the AMT.
AMT paid on ISO exercises becomes a minimum tax credit that can be recovered in later years when regular tax exceeds AMT.
Under the $100,000 rule, if ISOs first becoming exercisable in a year cover more than $100,000 of stock, measured at grant value, the options over the limit are treated as NSOs.
A worked example
A single employee with $220,000 of salary, taking the standard deduction, holds 40,000 ISOs at a $1 strike, and the latest 409A value is $11. Under 2026 rules, and assuming the value stays at $11, the alternatives compare as follows:
- Exercising all 40,000 at once creates a $400,000 spread, pushes her AMT income to $620,000 and into the exemption phase-out, and costs about $118,600 of AMT.
- Up to her crossover, she can add only about $30,500 of spread, or roughly 3,000 options, a year before AMT applies. Staying under it avoids AMT but would take more than a decade.
- If she exercises 10,000 a year for four years, each $100,000 spread costs about $18,100 of AMT, or roughly $72,300 in total, because her AMT income stays under $500,000 and keeps the full exemption.
Compared with a single exercise, the four-year plan saves about $46,000 of AMT. Each tranche also starts its holding period when exercised, and the AMT she pays can come back later as a credit.
In Connecticut
Connecticut has its own AMT, but it applies only to those who owe federal AMT. The tax equals the lesser of 19% of federal tentative minimum tax or 5.5% of federal AMT income, minus regular Connecticut tax, and is filed on Form CT-6251. If the employee above lived in Connecticut, her regular 2026 Connecticut tax on $220,000 would be $12,910. Each $100,000 tranche would add no Connecticut AMT, because 19% of her $59,774 federal tentative minimum tax is $11,357. For the single $400,000 exercise, 19% of $160,282 comes to $30,454, which is less than 5.5% of $620,000, or $34,100. After subtracting the $12,910 of regular tax, that exercise would add about $17,500 of Connecticut AMT. Any Connecticut AMT can be recovered in later years as a credit on Form CT-8801. See our Connecticut guide for more.
Common mistakes
- Exercising a large block in December at a high valuation with no plan to pay the AMT.
- Missing a disqualifying disposition that would have reduced the AMT after a price drop.
- Forgetting state AMT, such as California's.
- Not tracking AMT basis separately from regular basis on Form 6251 and Form 8801.
How Summer Associates helps
Summer Associates calculates your AMT crossover each year, models exercise and sale scenarios, and tracks AMT credits and dual basis on your returns.
Sources
This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.