Incentive Stock Options and the AMT: What Changed for 2026

Figures reflect rules in effect as of October 2026.

Exercising an incentive stock option creates no regular-tax income, but the gap between your strike price and the market value on the day you exercise is added to your alternative minimum taxable income. For 2026 the AMT exemption begins to disappear at $500,000 of AMTI for a single filer, down from $626,350 last year, and it disappears twice as fast.

If you hold ISOs at a Los Angeles employer, someone has probably told you to exercise early and hold for the long-term capital gain. That advice is not wrong. It is incomplete, because it leaves out the bill that arrives in April from a sale you never made.

The alternative minimum tax is a parallel calculation. You work out your tax twice, once under the ordinary rules and once under the AMT rules, and pay whichever is higher. Most things that create a difference between the two are small. An ISO exercise is not small. The moment you exercise and hold, the paper gain on those shares counts as income for the AMT even though you have sold nothing and received no cash.

What follows is how I think about three decisions: how many shares to exercise, when in the year to do it, and what to do if the stock falls afterwards. The third one is the one most articles bury. It is the same shape of problem as the one I wrote about in RSU withholding: equity compensation taxed on a schedule the tax forms do not make obvious. Both sit inside the wider question of planning around equity compensation.

What actually happens when you exercise an ISO?

Nothing, for the regular tax. The IRS is explicit: “For the regular tax, no income is recognized when an incentive stock option (ISO), as defined in section 422(b), is exercised. However, this rule doesn’t apply for the AMT.”³

For the AMT you add the excess of the stock’s fair market value over what you paid for it.³ Exercise 10,000 options at a $2 strike when the shares are worth $22 and you have added $200,000 to your alternative minimum taxable income. No shares sold. No cash received. Your employer sends you a Form 3921 in January showing the strike price, the value at exercise and the share count, which is the paper trail for the whole calculation.³

Two consolations. Your AMT basis in the shares goes up by the same amount, so the gain is not taxed twice when you eventually sell.³ And if you hold long enough, the later sale is capital gain rather than wages. “Long enough” means the later of one year after the shares were transferred to you and two years after the option was granted.⁴ Miss that and the discount comes back as ordinary income, reported on your W-2.⁴

Why 2026 is different

The AMT does not bite immediately, because there is an exemption that shelters the first slice of alternative minimum taxable income. For 2026 that exemption is $90,100 for a single filer and $140,200 for a married couple filing jointly.¹

The exemption then phases out as income rises, and this is where the law changed. Compare the IRS’s own figures for the two years:

Read the last two rows together. For a single filer the band where the exemption bleeds away now starts $126,350 lower and is half as wide. Mechanically, the exemption used to vanish at 25 cents per dollar of income above the threshold and now vanishes at 50 cents.¹˒²

For a Los Angeles professional earning $300,000 who exercises a meaningful block of options, that is the difference between a manageable AMT bill and a surprising one. The exercise that was affordable in 2025 may not be in 2026, and nothing about the options changed.

How many shares should I exercise?

This is the crossover question. Somewhere there is a number of shares you can exercise that adds enough AMT income to use up the exemption without pushing you far into AMT. Exercise fewer and you leave the exemption unused. Exercise more and every additional share costs you real tax on a gain you have not realised.

A simplified illustration, with a single filer at $300,000 of ordinary income and options struck at $2 when the shares are worth $22:

The shape is the point, not the numbers. The first tranche is cheap. The last tranche is expensive. The crossover sits where the exemption runs out, and in 2026 it arrives sooner than it used to.

A word about the arithmetic: a crossover calculation is a starting point, not an answer. It tells you nothing about whether the company will still be here in three years, whether you can afford the cash the exercise requires, or what a concentrated position in one employer does to the rest of your balance sheet. I have written separately about reducing a concentrated stock position, because for most people it matters more than the tax.

Can I split the exercise across two calendar years?

Usually, and it is the most useful lever after the crossover itself. The exemption resets every year. A block that would push you deep into AMT in one year may fit inside two years’ worth of exemption if you exercise half in December and half in January, three weeks apart.

Two things make that harder than it sounds, and both are worth saying out loud.

The price moves. The AMT adjustment is measured on the day you exercise,³ so the second half is priced at whatever the stock is worth in January, not at December’s price. If the shares run up, splitting cost you money. If they fall, it saved you some.

And the option has to still be exercisable. You must generally have been an employee of the company from the grant date until three months before you exercise.⁴ A split that straddles a resignation, a layoff or an acquisition can turn the second half into something else entirely. If you are thinking about leaving, the calendar is no longer the only clock running.

One more thing worth knowing if your employer is a private C corporation: exercising starts the clock on the shares themselves, which is also the clock that matters for the qualified small business stock exclusion. If that could apply to you, read how the QSBS rules work before you decide the timing on tax grounds alone.

When in the year should I exercise?

January, if the decision is otherwise finely balanced.

Not because of anything in the tax rules themselves. Because of the next section. Exercising in January gives you eleven months to watch what the stock does before the calendar closes the door on your best remedy. Exercising in December gives you days.

There is a second reason, less dramatic. An exercise early in the year gives you time to adjust withholding or estimated payments across the rest of it, rather than discovering the liability in March when the only option left is writing a cheque.

What if the stock falls after I exercise?

Here is the rule almost nobody mentions, in the IRS’s own words: “If you acquired stock by exercising an ISO and you disposed of that stock in the same year, the tax treatment under the regular tax and the AMT is the same, and no adjustment is required.”³ Publication 525 says it a second time: “no adjustment is required if you dispose of the stock in the same year you exercise the option.”⁴

Sell the shares in the same calendar year you exercised, and the AMT preference item goes away. Not reduced. Gone.

This is the thing that matters when an exercise goes wrong. You exercise in March at $22. By November the shares are $6. If you hold into January, you owe AMT on a $20 per share gain that no longer exists, on stock now worth less than the tax. If you sell by 31 December, the adjustment never happens. You give up the favourable holding period and the discount is taxed as ordinary income on your W-2,⁴ which is a real cost, but it is a far smaller one than paying tax on a gain that evaporated.

That trade is the whole reason timing matters. The remedy exists only until the year ends.

What California adds

California runs its own alternative minimum tax, and the same paper gain shows up there too. The state rate is 7%, applied on Schedule P after its own exemption.⁵ For 2025 the California exemption began to phase out above $252,203 of alternative minimum taxable income for a single filer and $504,411 for a married couple filing jointly.⁵ California had not published the 2026 Schedule P figures when this was written, so treat those thresholds as the 2025 ones and check the current form before relying on them.

The practical effect is that a Los Angeles exerciser is looking at a federal AMT charge and a state one on the same unrealised gain, in a state that taxes capital gains as ordinary income when the shares are finally sold. It does not change the strategy. It does change the number, and it is why the crossover calculation I would run for a client in Santa Monica looks different from the one a national calculator produces.

Do I ever get the AMT money back?

Often, eventually, in part. AMT paid because of an ISO exercise generally creates a minimum tax credit you can carry forward and use in later years when your regular tax exceeds your tentative minimum tax. The form is 8801, and the instructions put it plainly: if you pay AMT for one year, you may be able to take a credit the next.³

Treat that as a timing benefit rather than a refund. The credit comes back over years, in amounts you do not control, and it is worth less the longer it takes. Planning the exercise so the AMT is small beats planning to recover it.

The Bottom Line

An ISO exercise is taxed on a gain you have not received, and for 2026 the shelter against that tax runs out sooner and faster than it did in 2025. Decide how many shares to exercise by where the exemption gives out rather than by how many you hold. Exercise early in the year rather than late, so the remedy stays available. If the shares fall after you exercise, selling before 31 December removes the AMT adjustment entirely, at the cost of the holding period. And remember that California charges 7% of its own on the same paper gain. None of this is a reason to avoid exercising. It is a reason to decide the size and the date on purpose.

This is the kind of decision I work through with clients as part of an ongoing engagement rather than a one-off calculation, and what that costs is published on the fee page.

If you hold ISOs and want to work out the size and timing for your own situation, book a complimentary 15-minute call.