Exercise ISOs Between January and April
If your company is publicly traded, exercising ISOs early in the year will provide you with the most flexibility to optimize for AMT.
Strategy Overview
Strategically timing when you exercise ISOs can provide material benefits. If your company is publicly traded, a strategy to consider is intentionally exercising ISOs early in the year; ideally in January but no later than early April. This approach provides both (1) flexibility throughout most of the 1-year holding period to decide whether to (i) hold for a qualifying disposition or (ii) sell in the same year to avoid AMT, and (2) allows you to juggle the cash dynamic of owing/paying AMT and selling shares.
Tax Details
Exercising ISOs does not create/have a standard tax impact, but the bargain element is considered income for AMT purposes (see ISO Taxation for more details). If the ISOs have a large bargain element, the AMT impact can be substantial --> and you may not have the funds on hand to pay the AMT bill when its due (without selling the shares).
Fortunately, a timing strategy exists to help solve this dynamic. If you owe AMT, the payment is due in April of the following year. So for example, if you exercised ISOs on January 1st, 2022 you'd have 15.5 months until your AMT bill was due on April 15, 2023. That's more than 1 year, providing an individual with the opportunity to both:
Have nearly the full year of 2022 to watch the stock price and decide if selling (and triggering a disqualifying disposition) in the year is worthwhile; which it can be if the value of the shares declines materially in the year.
If shares are kept, the individual will meet the 1 year requirement of a qualifying disposition (e.g. on January 2nd, 2023) prior to when the AMT bill is due (April 15, 2023) --> and can sell the shares to raise the cash to pay the AMT bill. And as a bonus --> the sale will also help them recoup a strong portion of their AMT credit in the following year
Key Benefits
Flexibility to monitor the stock price and sell (avoiding AMT) if it makes sense. Exercising ISOs early in the year gives you the flexibility to monitor the stock's performance throughout the year. Depending on how the stock performs, you can then decide on the most tax-efficient strategy (see Sell ISOs in the Same Tax Year To Avoid AMT for more details).
Sell to cover AMT tax generated before tax deadline. Exercising ISOs can generate AMT. By exercising early in the year, you have time to sell some/all of the shares to raise the cash needed to pay your AMT bill prior to when it is due (in April the following year).
Key Considerations/Flags
Need funds for exercise cost upfront. Exercising ISOs requires you to pay the exercise price upfront. Make sure you have sufficient funds to cover this cost.
May be subject to trading windows restricting sale. Nearly all publicly traded companies have trading windows that restrict when employees can sell their shares. Check with your company to understand their policies and if/how it would likely impact your implementation of this strategy.
Investment/market risk. If your company is publicly traded, you have the choice to sell your shares immediately after you exercise your ISOs. Alternatively, you can hold to target a qualifying disposition (and the improved taxation), but doing so requires that you accept the investment risk for at least one year after exercising.
Strategy: When to Consider This and When to Avoid It
🟢 When to Consider This Strategy:
When your company is publicly traded and you own ISOs with a large bargain element. This situation is when a large AMT bill is most likely. If you are comfortable with the investment risk, this strategy will give you the flexibility to optimize your ISOs for AMT.
🔴 When to Not Use This Strategy:
Uncomfortable with the investment risk. If you are uncomfortable taking the investment risk of holding the shares for a one year period, you should likely exercise and sell the shares. Your taxation will be less favorable, but you won't have any go-forward investment risk from the holding.
Blackout periods or other trading restrictions (e.g. you're a pre-clearance individual) make the strategy unfeasible. Nearly all publicly traded companies implement blackout periods prior to reporting quarterly earnings, and senior company executives may have additional restrictions (e.g. sales require pre-clearance). Depending on the details, these restrictions could make this strategy less favorable, or even not applicable.
Cash Constraints. Exercising ISOs requires you to pay the exercise price upfront. If you don't have the cash to be able to do so, you likely will need to consider an alternate strategy (or combination of strategies).
Example
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