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If you’re earning incentive stock options (ISOs) at a publicly traded company, you might be curious if there’s any benefit to exercising your stock options now, or waiting to exercise at some point in the future.

If your company’s stock is trading far above your ISO strike price, there can be significant benefits to exercising now, rather than waiting. With careful planning, you might even be able to avoid AMT taxes.

When you were initially granted ISOs, you were given what’s known as a strike price — how much it will cost you to purchase a single share of your company’s stock.

When you purchase (i.e. “exercise”) your ISOs, you’ll pay your company that strike price, multiplied by however many shares you’d like to buy. For example, you might exercise 1,000 ISOs at a strike price of $10 each, writing your company a check for $10,000 in the process.

After exercising your shares, you’ll report to the IRS the difference between your strike price (also known as your cost basis), and the total value of those shares. For publicly traded companies, that’s the company’s share price on the day you exercised your ISOs.

This gain gets added to your alternative minimum tax liability (AMT). If you exercise enough ISOs in a single year, you can trigger an AMT tax bill.

If you want to avoid AMT, you can always exercise just enough ISOs each year to stay under the AMT threshold. We’ve built a free AMT threshold calculator to help you estimate how many ISOs you can exercise each year without triggering AMT tax liability.

Once you’ve exercised your ISOs, you now have to decide when to sell them. Some people decide to perform a cashless exercise — exercising their ISOs, and then immediately selling some or all of their resulting shares the same day, in what’s effectively treated as a single transaction by the IRS.

Cashless exercises are taxed as ordinary income — the highest possible tax rate.

Other people decide to exercise their ISOs and then hold onto some or all of their shares for more than a year before selling, to take advantage of long-term capital gains.

The major risk in waiting for long-term capital gains is that the company’s share price declines in the future. In some cases, people who waited to sell their shares found themselves facing large AMT tax bills, on top of heavy capital losses.

It can be risky to exercise ISOs if you don’t have enough money to pay for AMT, instead relying on future price appreciation to pay for your tax liabilities. Your company’s stock price could decline in the future, leaving you on the hook for an AMT bill that you can’t afford.

Want to learn more about stock options? Check out our educational resources at Secfi Learn.

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