If you exercised incentive stock options (ISO) in the last several years, you may have been hit with a hefty alternative minimum tax (AMT) bill.
The AMT is charged when you exercise your ISO, hold on to your shares, and sell them after the calendar year in which they were awarded to you.
The AMT is calculated based on the difference between the fair market value (FMV) of the shares on the date that you exercised the option and the exercise price.
Key Takeaways
- The AMT is charged when you exercise your ISOs, hold on to your shares, and sell them after the calendar year in which they were awarded to you.
- The AMT is calculated based on the difference between the fair market value of the shares on the date that you exercised the shares and the exercise price.
- The AMT credit can be used to lower your federal income tax bill when the amount you owe on taxes is more than what it would have been under the AMT.
- Between 2007 and 2012, investors got the benefit of making their unused AMT credits refundable.
- People who had exercised ISOs in the past could calculate their potential refundable AMT credit by using the 1040 Form worksheet for Form 6251 (line 45).
The AMT Credit
While no one likes to pay tax on a stock transaction, there is a tax law provision called the AMT credit that benefits taxpayers. The credit is a way that stockholders can offset the tax that they incur when exercising their ISOs.
When you pay your AMT bill, the AMT credit is automatically triggered. It can be used to lower your federal income tax bill when the amount you owe on taxes is more than what it would have been under the AMT.
That's because, unlike a deduction that lowers the total amount of income on which you are taxed, a credit lowers your actual tax bill dollar-for-dollar.
The Refundable AMT Credit
No longer available, however, is the tax benefit available to investors from 2007 to 2012 which made their unused AMT credits refundable.
This tax benefit was instituted in 2007 to help investors who found that the AMT credit did not significantly lower their federal income tax bill. Congress passed these tax law changes in 2007 and then amended them again in 2008.
However, the refundable AMT credit was not extended at the end of 2012, so the 2012 tax year was the last time that taxpayers could take advantage of this benefit.
The refundable AMT credit was not extended at the end of 2012, so the 2012 tax year was the last time that taxpayers could take advantage of this benefit.
Understanding Refundable AMT Tax Credits
Here is how the refundable AMT tax credit used to work.
The tax law changes that took effect in 2007 were designed to help people who exercised their ISOs and had to pay the AMT.
As a result, the Internal Revenue Service (IRS) deemed unused AMT credits that were at least three years old (sometimes referred to as "long-term unused AMT credits") to be refundable. That meant that taxpayers could claim those credits to:
- Reduce their current AMT bill
- Lower their current federal income tax bill dollar-for-dollar
- Carry qualified refundable credits over indefinitely (applying them to subsequent income tax bills)
- Collect leftover credits as a cash payment from the IRS
The law that went into effect in 2007 (for taxes paid in 2007 on 2006 earned income) permitted people to claim the greater amount of either 20% of their long-term unused AMT credit or $5,000. However, the IRS also put income limits in place to reduce the amount of credit that higher-income earners could claim.
Congress amended the law for 2008 by increasing the amount considered refundable.
Calculating the AMT Credit
People who had exercised ISOs in the past could calculate their potential refundable AMT credit by using the 1040 Form worksheet for Form 6251 (line 45), talking to a tax filing professional, consulting with an accountant, or using the IRS's online AMT Assistant.
Changes implemented in 2008 did not limit a taxpayer's credit to the total amount of income taxowed. Therefore, they could claim AMT credits that totaled more than the amount of money that was withheld for taxes, already paid in quarterly estimated tax, or that was owed on the current tax bill.
Effective in 2008 (for taxes paid in 2009 on 2008 earned income), taxpayers could claim the greater amount of 50% of long-term unused credit accumulated three years or more prior to the filing year or the amount of refundable AMT credit listed on the previous year's 1040 form.
Example
For example, if they had earned $80,000 in AMT credit in 2004 and none in subsequent years, they could claim $40,000 (50% of the qualified unused credit) when filing their 2010 taxes in April 2011.
To collect theirrefundable credit of $40,000, they would have needed to complete and send IRS Form 8801 to the IRS along with their 1040 Form.
However, let's say that you owed $11,425 in federal income taxes for filing year 2009. When the IRS received your Form 8801 (to claim your refundable credit of $40,000) it would have first deducted the amount you owed ($11,425) and then mailed you a check for the difference of $28,575.
The taxpayer would have been able to use the refundable credit to pay their federal income tax bill and receive a cash refund.
What's more, in 2011 they would have been able to claim $40,000 in refundable credit—the balance remaining from the 2008 refundable credit amount. The taxpayer could have collected that remaining credit when submitting the Form 1040 for 2010 taxes.
Unfortunately for taxpayers who could have continued to benefit, the refundable AMT credit provision was only available for six years (2007-2012) and Congress did not extend it or make it permanent.
Do You Pay the AMT When Exercising ISOs?
Yes, the spread between the strike price and fair market value of the stock when exercised is subject to the AMT. This spread is not taxed at the ordinary income tax rate.
What Triggers the AMT When Exercising ISOs?
Taxpayers may face the AMT when exercising ISOs if one of several conditions are met. These conditions may include but aren't limited to having a high household income with a significant amount of deductions, realizing a large capital gain, or exercising stock options that have a significant paper gain.
What Is the AMT Exemption Amount?
The AMT exemption amount is indexed to inflation and changes each year. For 2023, this amount for single filers is $81,300 and starts decreasing (phasing out) at $578,150. For those married and filing jointly, the exemption amount is $126,500 and starts decreasing at $1,156,300. For tax year 2024, those amounts for single filers are $85,700 and $609,350, respectively. For married couples filing jointly, they're $133,300 and $1,218,700, respectively.
The Bottom Line
From 2007 to 2012, the refundable AMT credit provision helped some taxpayers pay their AMT bill, recoup the money they paid out on their AMT bill, and pay their federal income tax bills.
Going forward, you may want to work with a professional tax preparer or tax attorney to ensure that you're correctly claiming credits (and deductions) to maximize your tax benefits, according to current tax laws.
