Does a private equity ISO exercise always result in an AMT carryforward credit (assuming AMT was paid that year)? If not, what are the situations which would block the carryforward credit?
I exercised some ISO options in 2019 and 2020, but neither of those triggered an AMT carryforward credit per form 8801 even though I had to pay AMT through the nose in 2020 (2019 tax year) and now again in 2021 (2020 tax year) per form 6251. I'm afraid I've missed something or was just very tax inefficient and would like to learn how to prevent this in the future.
No, a private equity ISO does not always result in an AMT carryforward. The ISO is treated as a non-qualified stock option for AMT purposes. This means the spread from FMV to exercise price is included in your income for calculating the AMT. This surprises many people when they sell, thinking they have a favorable tax treatment. Which you do, for regular tax, just not AMT.
An AMT carryforward is tracking the tax paid. Form 8801, Credit for prior year minimum tax, is used to determine if you deserve a credit.
Line 2i: Incentive stock options: This line is a common problem for people affected by the AMT. If you exercise an Incentive Stock Option (ISO) but do not sell the stock in the year of exercise, the transaction is not taxable that year for regular tax purposes.
However, the difference between the exercise price and the fair market value of the stock on the day of the exercise is an adjustment for AMT purposes and appears on Line 15. For many people, this adjustment can be a very large number. Essentially, you are going to be taxed on a hypothetical profit (what you might have made if you sold the stock on the day you bought it.)
You exercise Incentive Stock Options (ISOs) to purchase 100 shares of stock at $3 per share and you decide to hold the stock as a long-term investment. The stock is trading at $33 per share on the day of the exercise. Line 15 on your Form 6251 is $3000 (100 shares x ($33-$3 per share).
Your basis in this stock is now $300 ($3 x 100) for regular tax purposes, but $3300 ($33 x 100) for AMT purposes. When you later sell the stock, you will have an entry on Line 18, Disposition of Property Difference, to account for the difference in your tax basis for regular and AMT purposes.
Suggestion 1: If you exercise ISOs as in the previous example at $33 and the stock falls before the end of the current year, you can sell the stock and avoid the AMT. If the stock fell to $25 during the year of the exercise, you would be subject to regular tax on only $22 per share ($25-$3) and not be subject to the AMT adjustment at all.
Suggestion 2: When you exercise ISOs, always use tax planning software to forecast the tax consequences. You may need to sell some of the stock in the year of the exercise to pay the tax due.
Here's a TurboTax article about AMT.
Hi ReneeM7122, I understand how the tax rate for AMT is calculated, the part that isn't clear to me is the situations in which the carryforward credit is given and when not. I've exercised and sold ISOs 4x and twice I got a credit and twice I did not. How can I avoid missing out on this carryforward credit?