Are these Incentive Stock Options? If so, here's how it works in a nutshell:
Now:
* You pay your strike price to the company for the shares.
* No income is realized under the regular income tax formula.
* The difference between the current valuation and your strike price is considered income under the AMT formula. These option exercises often cause pretty large tax liability in the year of exercise due to the AMT piece.
When you sell (
if the sale is more than a year after you buy the shares, and more than two years after the option was granted):
* The difference between the sale price and your strike price is a long-term capital gain (or loss) under the regular tax formula.
* Under the AMT formula the difference between the sale price
and the value on exercise date is a long-term capital gain (or loss).
* If you don't owe AMT in that future year, you can claim a tax credit against the AMT you paid this year, up to the difference between what the regular tax formula says you owe and what the AMT formula says you owe.
As an example, let's say you have 10,000 shares with a strike price of $1, current valuation of $5, and eventual sale price of $10.
This year you pay the company $10,000. You need to report $40,000 of income for AMT purposes only. The amount of tax this will cause you to pay really depends on your individual circumstances outside of this stock transaction, but let's suppose it's $10,000.
Suppose the company is sold in late 2023, more than 12 months from when you bought the shares. You'll claim a $90,000 long-term gain under the regular tax formula, but only a $50,000 gain under the AMT formula because you were already taxed on that other $40,000 under the AMT in 2022. You will likely not owe any AMT in 2023 just because your AMT income is so much lower than your regular-formula income.
Now you need to take a look at the difference between your tax under the regular formula and your tax under the AMT formula (the "tentative minimum tax" on Line 9 of your
Form 6251). If this difference is more than the $10,000 AMT you paid last year, you likely get to claim the whole $10,000 as a tax credit on
Form 8801. If the difference is less than $10,000, you likely get to claim the full difference, leaving the remainder to carry over for a possible tax credit in 2024 or subsequent years. This can potentially drag on for a long time. I exercised some ISOs in 2013-14 and finally got the last of my AMT refunded a year or two ago.
If the sale is
less than 12 months from when you buy the shares (or less than two years from when you were granted the option), different rules apply that I'm less familiar with because I was never personally subject to them.
See
IRS Publication 525 for more info about all this.
