Leave an Employer in 4Q to Optimize AMT
If you leave an employer in 4Q, you'll likely have two tax years across which you can optimize your ISO exercises and AMT bill (versus just one)
Strategy Overview
If you are leaving an employer and have vested but unexercised ISOs, IRS rules stipulate that ISOs retain their preferential treatment/status for 90 days before converting into NSOs. Separately, most individual households have a certain amount if AMT income (via ISO exercises) they can incur without triggering an AMT bill.
Taken together, if you have some flexibility in regards to when you leave your employer, waiting until calendar Q4 can help you optimize your AMT tax bill, because you'll have two different tax years (and thus two years to incur some AMT without triggering an AMT tax bill).
Note: if you know you will leave your employer in the near future, this strategy can also be implemented by exercising some ISOs in Q4, even though your last date will not be until sometime in Q1.
Tax Details
Leaving an employer is an event that has a large number of strategic decisions you need to make regarding your stock-based compensation (see Company Departure Planning for more details). If you have vested but unexercised ISOs, one of the decisions you will be focused on is (1) do you want to exercise your unvested options, and if yes, (2) what strategies exist to help you optimize for taxes when you do so.
If your timing lines up, or you have some flexibility regarding timing, a strategy to consider is timing your departure to be in Q4 (October, November or December). The reasons for this takes advantage of a number of rules from the IRS and associated AMT tax laws:
When you leave an employer, IRS rules stipulate that ISOs retain their preferential treatment/status for 90 days before converting into NSOs. For more details see Exercise ISOs within 90 days of departure
Most individual households have a certain amount of AMT income (via ISO exercises) they can incur without triggering an AMT bill. For more details see Exercise ISOs up to the AMT Limit
When ISOs are sold, the sale can help accelerate the recoup of AMT tax credits (or widen the gap in the year before AMT is triggered). For more details see Sell ISO-Acquired Stock To Recoup AMT Tax Credit
Taken together, if you leave an employer in Q4, the 90 days you have will span two calendar years. This gives you the opportunity to both (1) utilize the amount of AMT income you can incur without triggering an AMT bill across two years, as well as (2) in the second year potentially have a larger AMT income window without triggering an AMT bill if you sell the ISO-acquired stock from year 1 twelve months later in year 2.
Key Benefits
Utilize two "free windows" to exercise ISOs without triggering AMT (versus just one). ISOs have preferential tax treatment, but exercising them can result in unwelcomed AMT bills. When you leave an employer and the options do not have a PTEP, you have 90 days to exercise before they expire. In Q4, that 90 days spans two calendar years, giving you two "free windows" (of AMT income you can incur in a year without resulting in an AMT bill) --> which can double (or more) the number of ISOs you can exercise without incurring an AMT bill.
Delay the payment of AMT bill (if one is due). If the exercise of ISOs results in you owing AMT, the tax bill is due in April of the following year. In Q4, you have the option of exercising some (or all) of the ISOs in the next tax year, which will push the date your AMT bill owed back 12 months (e.g. a 12/31/22 exercise would be due 4/15/23, while a 1/1/23 exercise would be due 4/15/24)
Your second year AMT window can be larger if you sell the ISOs from year 1. Selling ISO-acquired stock helps accelerate the recoup of an AMT credit and/or widens the amount of AMT income that can be incurred in a year without resulting in an AMT bill. If you sell the year 1 ISO-acquired stock in year 2, the amount of AMT income you can incur in year 2 without triggering an AMT tax bill will be larger (amplifying the benefit of this strategy).
Key Considerations/Flags
Implementing this strategy likely requires tax forecasting done by a tax professional. AMT is difficult to forecast. Most free tools miss the mark, and they also typically require a solid understanding of income taxes to utilize correctly.
The benefits of this strategy can be diminished (or fully negated) if you have significant AMT credits (likely from prior ISO exercises). If you have AMT credits in prior years, they are subject to recoup each year. The "window" to incur a certain amount of AMT income without triggering an AMT bill still exists, but its not longer "free" because not using it would allow you to recoup some/all of your AMT credit.
Strategy: When to Consider This and When to Avoid It
🟢 When to Consider This Strategy:
When you leave an employer in Q4 (or possibly Q1) and you have in-the-money ISOs you would like to exercise.
🔴 When to Not Use This Strategy:
If you otherwise wouldn't plan on exercising your ISOs. Exercising ISOs is foremost an investment decision. If you don't believe in the company's business prospects and/or have decided you do not want to exercise, then the tax benefits aren't worth the investment risk.
If the ISOs have little or no bargain element. AMT income is only generated by the amount of the bargain element the option has. If your ISOs have little or no bargain element, AMT is likely not a material concern (if any at all), and thus a strategy to minimize is not applicable.
🟡 Consider on a Case-By-Case Basis:
If you already have sizable AMT credits (likely from previous ISO exercises). AMT credits are subject to recoup each year. Any AMT income generated from exercised ISOs will reduce/eliminate the amount of AMT credit you can recoup that year, so you need to weigh the pros/cons accordingly.
If you don't have a reasonable understanding of AMT and don't have (or want to pay) a professional for help. Modeling AMT is complex and depends on your unique situation. If it's done incorrectly, you have risk in both directions: (i) underestimating the "free window" and not utilizing it fully, and (ii) overestimating the "free window", resulting in AMT being due.
Example
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