Entering Incentive Stock Options in Scenario Analysis
Under the regular tax system, exercising Incentive Stock Options (ISOs) is not a taxable event. This is different than the exercise of Non-qualified stock options (NSOs), where any increase between the grant price and the market price at exercise is considered ordinary income.
For AMT purposes; however, the difference in the exercise price and the fair market value of the stock at the time of exercise for a qualified ISO exercise is a preference item. This discount element needs to be inputted in line 2i of the AMT section.
Assuming that the rules for a qualifying disposition have been met, the sale of any shares obtained through an ISO exercise would be eligible for long-term capital gains treatment and should be included with any other gains for the year the Schedule D section.
Long-term capital gains also receive preferential treatment for AMT purposes. But in the case of shares obtained through ISO exercise, the cost basis for AMT purposes will be different compared to the regular tax calculation.
In the regular tax calculation, cost basis will equal the amount paid for the shares, or the number of shares obtained multiplied by the strike price. For AMT purposes, the cost basis is equal to the cost of the shares plus the bargain element of the exercise, resulting in a higher cost basis.
Accordingly, the same sale will have different amounts of capital gains for the standard tax system and the AMT tax regime. You will want to calculate and enter the gains separately for both systems and enter them in the appropriate sections: Schedule D (regular tax system) and AMT Capital Gains (AMT system).
To account for this - and to get an accurate calculation of AMT - you will need to enter the difference in gains between the two systems as a negative adjustment in Row 2k ("Disposition of Property) of the "Alternative Minimum Tax" section. Be sure, however, that you are only calculating the adjustment for those gains that are different between the two systems. If gains are the same for both the standard and the AMT system, then no adjustment is necessary.
To watch Ben Birken, VP of Client Success and Engagement, go over ISOs, see below.