The bill that arrives for shares you can't sell
An engineer at a well-known startup exercised 20,000 vested ISOs last February. Strike price: $1. Current 409A: $6. She wrote a check for $20,000 to the company for the exercise cost and held the shares — because that's what her friends had told her to do. Long-term capital gains treatment. ISO advantages. Don't sell early.
In April of the following year she got a tax bill. Not for selling anything — she still owned every share she exercised. The bill was for $28,000 in alternative minimum tax on the $100,000 spread between her strike price and the 409A at exercise.
She had never sold a share. The shares were still worth nothing on paper because the company was private and there was no liquid market. She'd already spent $20,000 in cash to exercise. Now she owed another $28,000 to the IRS. Total cash outlay: $48,000. Shares she could actually sell: zero.
This is the AMT tax bomb, and it detonates for thousands of startup employees every year. Most of them don't know it exists until it hits them.
What AMT is and why ISOs trigger it
The alternative minimum tax is a parallel tax system that runs alongside your regular income tax. Every year, the IRS calculates two numbers — your regular tax bill and your AMT bill — and you pay whichever is higher. For most people, regular tax is higher and AMT never enters the picture. For startup employees exercising ISOs, AMT frequently becomes the higher number.
ISOs get their name — Incentive Stock Options — because they qualify for preferential tax treatment. When you exercise an ISO and hold the shares long enough, any gain when you eventually sell qualifies for long-term capital gains rates rather than ordinary income rates. That's the "incentive."
Here's the catch. The spread between your strike price and the 409A fair market value at exercise — called the bargain element — is invisible to your regular tax calculation but counts as income for AMT purposes. The IRS treats that spread as a "preference item" specifically because ISOs would otherwise let you defer tax on real economic gains.
The result: you can owe substantial tax on paper gains from shares you haven't sold, don't have a market to sell in, and may never be able to sell.
The math that produces the tax bomb
Let's walk through it with real numbers. Assume you're a single filer in California, earning $180,000 in salary, exercising 20,000 ISOs at a $1 strike price when the 409A is $6.
Your exercise cost is straightforward: 20,000 shares × $1 = $20,000. You write that check to the company.
Your bargain element is: 20,000 × ($6 - $1) = $100,000. This does not appear on your W-2. It does not affect your regular income tax bill. But it is added to your AMT income.
The AMT calculation: start with your regular taxable income (~$168,000 after standard deduction). Add the $100,000 bargain element. That's $268,000 in AMT income. Subtract the 2025 AMT exemption for single filers of $88,100. Your alternative minimum taxable income is $179,900.
Apply AMT rates: 26% on the first $232,600 (2025), 28% above that. Your tentative minimum tax: $179,900 × 26% = $46,774.
Compare to your regular tax on $168,000 (approximately $32,000 federal for a single filer at that income level).
You owe the difference: $46,774 - $32,000 = $14,774 in additional federal AMT. California adds its own 7% AMT on top for another meaningful chunk.
Total additional tax bill from exercising: roughly $20,000-$30,000 on top of the $20,000 you already spent to exercise. All triggered by paper gains on shares you still own and can't sell.
The 2025 law change: what OBBBA means for you
The One Big Beautiful Bill Act, signed into law in July 2025, made the higher AMT exemptions from the 2017 Tax Cuts and Jobs Act permanent. This is genuinely good news — without OBBBA, exemptions would have reverted to pre-2017 levels at the end of 2025, dramatically expanding the number of people caught by AMT.
But 2026 brings a less-friendly change. Starting in 2026, the phase-out threshold for married-filing-jointly filers drops from $1,252,700 to $1,000,000, and the phase-out rate doubles from 25% to 50%. The exemption disappears faster as income rises.
Practical implication: 2025 is genuinely a better AMT environment than what's coming in 2026 for higher earners. If you're considering exercising ISOs and your household income is meaningful, exercising in 2025 rather than 2026 may reduce your AMT exposure. But this is highly situation-specific and requires actual modeling.
You can pay $50,000 in tax on shares you can't sell. AMT taxes paper gains, and there is nothing paper about the check you have to write.
The five decisions that determine your AMT exposure
When you exercise. Exercising in January versus December of a given tax year changes nothing about your total tax bill for that year — but exercising in January gives you 12 months to model the impact, adjust withholding, and consider partial mitigation strategies. Exercising in November leaves you with a bill you can't easily plan around.
How much you exercise. Exercising 20,000 options at once triggers a larger AMT bill than exercising 5,000 options across four tax years. Spreading exercises keeps your bargain element small enough each year to potentially stay within the AMT exemption. This is the single most powerful lever for most employees.
Whether you hold or sell. If you sell your exercised shares in the same calendar year as the exercise, the transaction becomes a disqualifying disposition. The bargain element flips from AMT income to ordinary income on your W-2, and you avoid AMT entirely — but you lose the long-term capital gains treatment that was the point of holding ISOs. This is the escape valve for employees who suddenly realize their AMT bill is unmanageable.
Whether you pair ISO exercises with NSO exercises. Counterintuitively, exercising NSOs in the same year as ISOs can reduce your AMT. NSOs generate ordinary income, which raises your regular tax bill. AMT is the difference between AMT calculation and regular tax. Higher regular tax means less AMT owed.
Whether you plan for the AMT credit. AMT paid on ISO exercises creates a credit you can carry forward indefinitely. In future years when your regular tax exceeds AMT, you can use the credit to reduce your regular tax bill dollar-for-dollar. For most people, recovery of the credit takes 3-10 years and requires strategic planning around when you sell your ISO shares.
What to do about it
Four concrete actions if you have vested ISOs and are considering exercising:
Run an AMT projection before you exercise. Not after. Use tax software or hire a CPA who specializes in equity compensation. Guessing costs orders of magnitude more than the CPA fee.
Exercise early in the calendar year. January through March gives you the maximum time to react if the projection shows AMT exposure. December exercises leave you with no options.
Spread exercises across multiple tax years when possible. Instead of exercising 20,000 options in one year, consider 5,000 per year across four years. This keeps your bargain element small enough each year to potentially stay within the AMT exemption.
Model your AMT credit recovery. The AMT you pay isn't necessarily permanent tax — it's often a timing issue. But recovery requires you to eventually have regular tax exceed AMT, which typically means selling your ISO shares in a year with no other ISO exercises. Plan the sell year the same way you plan the exercise year.
The takeaway
AMT is the least-understood and most-expensive tax mechanic in startup equity compensation. It hits employees who did nothing wrong — they exercised valid options at their disclosed strike price and held the shares as advised. The tax bill arrives months later, for tens of thousands of dollars, on paper gains they cannot convert to cash.
The good news: this is entirely predictable and largely manageable. Every employee who understands the math before exercising can either avoid AMT, plan for it, or make an informed decision to accept it in exchange for the tax advantages of holding ISO shares long-term. The employees who get hit blindly are the ones who exercised without understanding what they were doing.
Don't be one of them. Run the numbers before you write the check.
Want to walk through AMT scenarios with real numbers before making an exercise decision? Try the Tax topic pack on Gargiulo — scenarios covering AMT triggers, credit recovery, ISO vs NSO tradeoffs, and the timing decisions that determine your bill. Sterling has spreadsheets.
Sources: IRS Form 6251, One Big Beautiful Bill Act (2025), Kitces, Darrow Wealth Management, WealthGen Advisors, and Julie Merrill CPA.