Alternative Minimum Tax (AMT)
Definition
A parallel tax system designed to ensure high-income individuals pay a minimum level of tax. For equity compensation, AMT is triggered when you exercise ISOs and the spread (FMV minus strike price) is large. The AMT adds this spread to your income for AMT calculation purposes, potentially creating a tax bill even though you have not sold any shares and received no cash.
Real-World Example
You exercise 20,000 ISOs at $1 strike when FMV is $15. The $280,000 spread is an AMT preference item. Even though you received no cash, you may owe $50,000-$80,000 in AMT. If the stock price later drops below $1, you still owe the AMT but your shares are now worthless — the nightmare "AMT trap."
Common Mistake
Exercising a large batch of ISOs in a single year without calculating AMT exposure first. Many people exercise early in the year thinking they will sell shares to cover taxes, then get stuck when the company has no liquidity event. Always model AMT before exercising.
Why It Matters
AMT is the single biggest financial risk for startup employees with ISOs. People have lost homes over unexpected AMT bills. Understanding AMT before exercising is not optional — it is essential.
Related Terms
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