If you're in tech and exercised incentive stock options, you may have discovered that holding the shares can trigger Alternative Minimum Tax, even though you never sold anything and never saw a dollar of cash. Amy Walls breaks down why that phantom income creates a real tax bill, and why that bill isn't gone for good, it becomes a credit you can recover.
This episode walks through how the minimum tax credit tracked on Form 8801 actually gets recovered, why the 2026 changes to the AMT exemption phase-out under the One Big Beautiful Bill Act pull more tech professionals into this exact situation, and why some people recover their full credit while others end up with a portion permanently stranded.
You'll learn:
(00:00) Intro
(00:54) Why AMT Can Become a Future Tax Credit
(02:22) Why You Owe Tax Without Selling Shares
(02:30) Understanding the ISO Bargain Element
(05:11) Why AMT Matters More in 2026
(07:12) Priya’s $200,000 AMT Example
(09:47) Do You Always Recover the Full AMT Credit?
(10:53) Qualifying Dispositions and Capital Gains
(11:51) Understanding a Stranded AMT Credit
(12:31) How to Plan Before Exercising ISOs
(12:40) Why ISO Planning Should Be Multi-Year
(15:06) How to Contact Thimbleberry Financial
[Intro Playing]
Jon Gay (00:09):
Welcome back to ThimbleberryU. I am Jon Jag Gay, Amy Walls from Thimbleberry Financial is with me. Hey, Amy.
Amy Walls (00:14):
Hey, Jag.
Jon Gay (00:15):
So, today, we're talking about something that a lot of you in tech have lived through without maybe fully understanding what happened afterward, “what had happened.” And that question is, how do I recover the AMT (Alternative Minimum Tax Credit) after exercising ISOs?
Maybe you exercised some of those incentive stock options a while back, you held onto the shares, got the tax bill, and it didn't really match anything you actually saw in your bank account. You paid it, you filed it, you mostly moved on, but you kind of had that little nagging feeling that there should have been some credit for that money out there somewhere.
We're going to dive into that today, Amy. Is that actually true? And if so, how does somebody get that money back?
Amy Walls (00:54):
So, Jag, the answer is you get that back in future years. The way to think about this isn't that with alternative minimum tax, you lost money; and that when you didn't get it back, it's lost. It's actually money you've prepaid against future years. And hopefully, you will get it back if the situation arises and the stars align, if you will, for you to have room to get that back.
Since we're talking specifically about the exercising of incentive stock options, ISOs, when you exercise ISOs and hold onto the shares, the IRS runs not just your normal tax calculation, but a second tax calculation, and that's the alternative minimum tax. And they run alongside each other.
So, you've got your regular tax calculation and then you've got this alternative minimum tax calculation. If that second calculation comes out higher, you're going to pay the higher number, even though with ISOs and the exercising of ISOs, you probably didn't even sell anything. Therefore, you didn't receive cash.
For alternative minimum tax, what you're really paying, if you end up paying it, is the difference between that higher bill and the lower bill, and the difference there that you're paying is a credit.
Jon Gay (02:22):
Amy, so walk me through why this even happens at all. If I haven't sold anything, why would I have paid tax like I did?
Amy Walls (02:30):
Your regular tax return only counts income that you've actually realized, money that's landed in your hands. Exercising and holding ISOs usually create zero income under those rules as I just talked about. But AMT works differently. It counts something called the bargain element, which is the gap between the strike price, which is what you paid to exercise, and the fair market value of the shares on the day you exercised.
So, basically, the government is saying there's this gap here. If we don't count that, that's going to be free money in the future. And so, they're saying we're going to look to apply tax to that today. So, let me give a simple version of this.
Say your strike price, what you paid to exercise, is $10 a share. That was announced at the time the shares were given to you, but the shares are actually worth $50 today when you exercise. That's a $40 bargain element that basically you got a big discount on.
Jon Gay (03:45):
Sure.
Amy Walls (03:46):
And AMT (alternative minimum tax) is going to count that full $40 as income even though you didn't sell a single share.
Jon Gay (03:54):
Wow, okay.
Amy Walls (03:55):
So, if you exercise a meaningful number of shares and we have a large bargain element, that phantom income can be large enough to push your alternative minimum tax number. It's officially called your tentative minimum tax, above what you'd owe under your regular tax return.
And so, when that happens, like I mentioned, you're going to pay whichever is higher, which in this case, in the example we're talking about, is going to be the alternative minimum tax number (say that 10 times fast).
I imagine the next question on your mind or some of our listeners is how does this actually happen? Well, the IRS actually tracks it every year on a specific form. It's a Form 8801; so that the amount you've paid and that's owed back to you (because it is) doesn't get lost.
And I get it's messy and it feels like, gosh, why am I paying extra tax? And that can feel like confiscation of your money. It's really a timing issue because there is a gap there that is earnings. And unfortunately, that timing gap can run for years.
Jon Gay (05:11):
So, full disclosure, we're recording this on August 6th of 2026. Why is this a bigger deal in 2026? It feels like this could have been just a footnote a couple years ago. It's different now, right?
Amy Walls (05:22):
The rules changed. That's the bottom line. Under the Big Beautiful Bill Act, they changed in a direction that pulls more people into AMT, not fewer.
So, every alternative minimum tax calculation starts with an exemption, an amount of income protected from AMT entirely. That exemption phases out, meaning it shrinks as your income rises. So, basically, we've got income coming up, and this exemption is getting phased out as a result. Once they come together, that's where this is an issue.
So, in 2026, under that act, the phase out starts at $500,000 for single filers, and a million dollars for joint filers. Those thresholds previously were $626,000 and $1,252,000.
Jon Gay (06:20):
So, it dropped, so more people would be subject to this phase out.
Amy Walls (06:24):
Yep. Additionally, the phase out rate itself doubled from 25 cents of exemption lost per dollar to 50 cents. So, it just got bigger. That's the simple answer. So, if you cleared this comfortably in 2025, and you're exercising ISOs, probably don't want to approach this with the idea of “I'll be fine.” We might want to dig a little further.
Jon Gay (06:56):
A lot of this is a concept and rules and laws that it'd be a little hard to follow. We're going to have show notes, and of course, you can always reach out to Amy and her team. But maybe it might help our listeners if we did sort of a real-life example here, Amy. Can you paint a picture of how this actually would play out for someone?
Amy Walls (07:12):
Yeah, fair enough. So, let's talk about Priya. Priya is a software engineer at a mid-size tech company. She exercised 5,000 ISOs at a $10 strike price when the stock was worth $50. So, again, we have that $40 bargain element we talked about previously, but we multiply that by 5,000 for the 5,000 shares. So, Priya has $200,000 of income for alternative minimum tax purposes.
Jon Gay (07:42):
$200,000. She hasn't actually seen that money, but that's counted toward the AMT.
Amy Walls (07:47):
Exactly. So, that's enough given her other income sources and her other equity comp included in that, that Priya is pushed into paying tax at the alternative minimum tax rate that year or this year instead of her regular rate. And the gap between those numbers is going to be a credit for her in the future.
So, here's where it can split into two different outcomes, though. Say the stock keeps climbing. She's already exercised this. And two years after she exercises, she sells in a qualifying disposition, meaning she gets the preferential tax rate because she followed all the rules on the incentive stock options, or on the shares that came from those.
Her regular tax that year is high because of the capital gain from the sale. So, she's going to actually, or will likely, recover most of that credit a couple of years from now. Now, the flip side is the stock price actually drops after she exercised.
Priya still owed the original AMT, let's say this year, but her gain when she does sell is much smaller or there isn't one because of that decline. So, now, there's less room for her regular tax to come in above alternative minimum tax.
So, that means that two years from now, in opposition to the scenario we first talked about, that credit is still just going to sit there with the IRS until she has an opportunity where her regular tax comes in above her AMT.
Jon Gay (09:47):
So, you talked about that credit just kind of sitting there with the IRS. Does everyone who goes through this actually get, or eventually rather, get their full credit back?
Amy Walls (09:58):
Oh, Jag, it's the government.
[Laughter]
So, no, not automatically. And this is the part that trips people up a lot. When you pay AMT, you're originally paying that at 26% or 28%, and specifically with ISOs on that bargain element that we talked about from a couple of minutes ago.
Recovering the credit works best through that qualifying disposition that I talked about with Priya, which is selling the shares after holding them at least a year past exercise and two years past the original grant. And listeners, if this is one of your first episodes joining us, if you go way back into the archives, we've talked about incentive stock options quite a few times. I'm probably due to talk about it again.
Jon Gay (10:52):
I’ll make a note of that.
Amy Walls (10:53):
So, when you sell under a qualifying disposition, the sale of the shares is taxed as long-term capital gains. That's the beauty of ISOs. Long-term capital gains tax rates top out currently at 20% for federal versus the 28% that is potential on AMT. So, that's a big savings right there.
So, in this scenario, Jag, to get to your question, you pay in at the higher AMT. So, AMT can remain permanently, if you will, uncovered. And in the planning world, that's called a stranded credit. Now, how much gets stranded depends on the size of your original spread, how long you held the shares, and what your income looks like in the year you actually sell the shares.
Jon Gay (11:51):
You're talking about stranded. I'm just picturing a sack of money sitting on the side of the road as the IRS drives away.
Amy Walls (12:00):
(Laughs) It's a little bit like that. It feels a little, I imagine this just very messy puzzle (laughs).
Jon Gay (12:08):
You do love your puzzles. (Chuckles)
Amy Walls (12:12):
So, if stock also drops in value, like I mentioned in Priya's example between exercise and sale, it gets worse because the capital losses are used against your ordinary income. And ordinary income's even lower, making it harder to recover those dollars.
Jon Gay (12:31):
So, let's back up a second here, Amy. If somebody's sitting on those unexercised ISOs right now, how do you help them plan and think this through ahead of time?
Amy Walls (12:40):
Well, first of all, this isn't a decision made once a year during a grant vest or an open enrollment window? It is a multi-year projection that gets updated. We're going to model what your regular tax and your tentative minimum tax looks like in the current year, next year, and often, in the year we're planning, that you're going to sell.
And that's going to tell us whether an exercise this year creates a credit you can use soon or one that's going to sit on the books for a long time. Now, Jag, full and fair disclosure, as you know, I'm not a CPA and this isn't going to be when we do it an official tax preparation. It's planning level modelling. It's close estimates. Obviously, it's projection, so what's going to happen in your life two years from now? We don't completely know.
But we've run the numbers, we've looked at it to have a conversation so that you can also be saying, "Okay, here's what I'm planning …" by planning a big job change at that point, what else do I think might be happening in my life?
And so, what that means is we're being forward-looking, we're being intentional about how these ISOs are treated, what they do to your taxes, when the timing is, and coordinating it with all the things in your life and how you need this money to be used for your goals so that this beautiful picture on a puzzle can be as beautiful as you want it to be.
Jon Gay (14:16):
There you go. We've talked before about a financial advisor who helps you plan forward or as a CPA is looking back at the previous year to get the taxes files. And so, in a perfect world, you're having them work together on your same team.
Amy Walls (14:29):
Absolutely.
Jon Gay (14:30):
So, here's my takeaway from everything we've talked about today, Amy. You just walked through-
Amy Walls (14:35):
Do you need a drink?
[Laughter]
Jon Gay (14:38):
I am three hours ahead of you, so it is five o'clock somewhere (laughs).
So, you walked through how the AMT bill isn't the end of the story. It's the start of this credit that you actually have to manage to get it back. And everything you laid out about the 2026 rule changes, it sounds like a lot more of our listeners are going to run into this than would've expected to.
So, if you're sitting on ISOs, you want to know what your own numbers look like, how can listeners reach out to you and the team at Thimbleberry Financial?
Amy Walls (15:06):
Yeah, they can find us online at thimbleberryfinancial.com, or give us a call. We do like picking up the phone: 503-610-6510.
Jon Gay (15:17):
Good stuff, Amy, we'll talk again soon.
Amy Walls (15:18):
Sounds good.
[Outro Playing]
Jon Gay (15:19):
Securities offered through registered representatives of Cambridge Investment Research, Inc., a broker-dealer, member of FINRA/SIPC. Advisory services through Cambridge Investment Research Advisors, Inc., a registered investment advisor. Cambridge and Thimbleberry Financial are not affiliated.
Discussions in this show should not be construed as specific recommendations or investment advice. Always consult with your investment professional before making important investment decisions.
Securities offered through registered representatives of Cambridge Investment Research, Inc., a broker-dealer, member of FINRA/SIPC. Advisory services through Cambridge Investment Research Advisors, Inc., a registered investment advisor. Cambridge and Thimbleberry Financial are not affiliated.