Stock option newbie, AMT question

[Stoutstache]

Hi! Long time lurker, first post. I have a tax question regarding stock options and AMT, I was hoping to get help from some of you more knowledgable about tax law than I. My husband has stock options in a company that is not public but likely will be within a few years. They are ISOs and we would like to buy some this year but I know there are AMT implications. I want to determine how many I can buy before we hit AMT. Some info:

Married, 2 dependents.
Total gross income about 165k minus 18,500 401k deduction
For taxes assume standard deduction for 2018
Strike price is somewhere around $1 and current value somewhere around $11. These numbers aren’t exact but close enough, I can do the math adjustments later if someone tells me how to do the calculation.

Is there any other info needed to determine how many we can buy and stay below AMT threshold?

Thanks for any help!

[sokoloff]

AMT for most W-2 earners is just a timing difference (meaning you'll end up "using up" the AMT excess at some point anyway). From a cashflow perspective, I get wanting to avoid it, but if you're fairly sure the ISOs won't turn up worthless, I recommend taking a look at the capital gains prospects instead.

Suppose you think the company will IPO (or be acquired by a public company) in N years and you'd like to sell the last shares at N + P years. (P = 1/2 if you want to sell immediately after a 180 day typical lockup period.)

Take (N + P + 1) and divide the number of ISOs you have by that figure.
Figure out any oddity around tax year boundaries.
Buy (exercise and hold) that many per year.

This ensures that you will buy the least amount per year [minimizing cashflow and AMT] and for all shares sold you will meet the 2 years since grant and 1 year holding period required to have the gain treated as a long-term capital gain. If there are other tax incentive programs that the stock qualifies for (typically not for an IPO-likely company), make sure you meet those terms and holding periods if desired.

Alternately, if you think there's still risk of going to $0 or an IPO being delayed in a market meltdown, do the math above, but calculate the "N" as starting 2 or 4 years from now and implement this plan 2 or 4 years from now (more shares per year, but zero risk in the interim).

AMT is not necessarily something to be avoided at the expense of other cashflow, risk, and capital gains term questions. I got whacked a lot by AMT in 1996, but was able to use up all the credits in only a few years after that. I wish I'd have better managed the short vs long term capital gains aspects, even at the expense of paying more AMT temporarily.

[seattlecyclone]

I went through this situation several years ago with my previous employer. When I started it was a private company that was on a strong trajectory toward IPO. I stayed on through the IPO and left a year later. I exercised many of my shares prior to the IPO, at a much lower valuation than afterward. Many of my coworkers were not even aware that this was a possibility and paid a bunch of extra tax as a result.

While it's true that the AMT treatment of ISO income does technically just shift the timing of your income, and you can get a credit for this AMT in future years, the maximum credit each year is limited to the amount that your tentative minimum tax in that future year is less than your regular tax. This means you may take many years to get this money back, if it ever happens. I still haven't used up my prior year AMT credit even though the IPO was five years ago and I exercised my last ISO share four years ago. Also there's no inflation adjustment for this stored-up credit. If you can time your exercises to avoid AMT, it can certainly be worthwhile to do so, provided you're reasonably certain an IPO or other liquidity event is forthcoming. In no case should you invest money you can't afford to lose into this illiquid private equity.

There's no easy way to answer the question of how much additional AMT-only income you could have without seeing your tax bill increase due to AMT. It varies so much based on your individual tax situation. You really just need to play around with Form 6251 and see how much income you could add on Line 14 (from exercise of ISOs) without causing Line 33 (tentative minimum tax) to be higher than Line 34 (regular tax).

One big wrinkle is that the 2018 tax reform greatly increased the threshold for AMT exemption phaseouts, so playing around with the 2017 versions of the form probably won't be very useful. It might give you a good number that would be sure to avoid AMT, but the real number this year could be much higher. I expect this change to finally let me use up the last of my AMT credits from 4-5 years ago.

[Stoutstache]

Thank you both for the replies.  I'll play around with the 6251 form as best I can using the 2018 phaseout thresholds and deduction amounts. 

I'm guessing IPO will be within 2 years or so. Not a ton of time to buy all the shares we want to without paying a lot of tax on a (currently) unsellable investment. If we do buy some shares now we can at least have the option of selling a portion of our shares between the lockout period and the 1 year mark and still get the long term cap gains rate. The company is a good one and they are profitable, I don't expect the shares to be worthless, I've just read a lot of horror stories from the dotcom era about people spending hundreds of thousands on taxes for shares that ended up being worth nothing and I'm afraid of making a dumb mistake. I have the money, I wouldn't be borrowing to buy the shares or anything, but we would probably be cashing out other investments to pay any AMT tax which is scary to me.

For the AMT credit to be used toward future years, is that something you can look up with the IRS somewhere or do you just have to keep track on your own of how much you use up each year and how much you have left?

[MDM]

Thank you both for the replies.  I'll play around with the 6251 form as best I can using the 2018 phaseout thresholds and deduction amounts. 

See the case study spreadsheet if you don't want to start with a blank sheet.

[seattlecyclone]

For the AMT credit to be used toward future years, is that something you can look up with the IRS somewhere or do you just have to keep track on your own of how much you use up each year and how much you have left?

That's on Form 8801. In it, you calculate your prior year AMT credit. The last line of Part II is a carry-forward that you will use as an input for the next year's Form 8801.