Incentive Stock Options (ISOs)
Stock options with preferential tax treatment — capital-gains rates if you hold long enough, but exercising and holding can trigger the AMT.
ISOs can qualify for long-term capital-gains treatment if you hold the shares long enough (two years from grant, one from exercise), but the spread at exercise is an AMT preference item that can create tax on a paper gain. The planning game is threading exercises to capture the tax benefit without an outsized AMT bill — and knowing what happens if the stock then falls. It rewards modeling before you click “exercise.”
Why ISOs get favorable treatment
Incentive Stock Options can qualify for long-term capital-gains rates on the entire gain if you meet two holding periods: hold the shares more than two years from the grant date and more than one year from exercise. Hit both and the spread that would otherwise be ordinary income is taxed as a long-term gain instead. Miss them and you have a “disqualifying disposition,” taxed largely as ordinary income.
The AMT cost of waiting
The catch is the Alternative Minimum Tax. Exercising and holding an ISO creates a preference item equal to the spread at exercise, even though you've sold nothing — so the very act of qualifying for the better rate can generate an AMT bill on a paper gain. Sizing the exercise against your AMT crossover is the central ISO decision.
How Formation handles it
Formation tracks each ISO grant's strike, vesting, and exercise dates, watches the two holding-period clocks, and charts where additional exercises tip you into AMT — so you can plan a multi-year exercise ladder with your CPA instead of discovering the tax on the return.
A worked example
You exercise ISOs and hold. Sell more than one year after exercise and more than two years after grant, and the full gain is long-term. Sell early — say nine months after exercise — and it's a disqualifying disposition: the spread at exercise becomes ordinary income, and only the appreciation after that is a capital gain.
Frequently asked
What are the two holding periods for ISOs?
More than two years from the grant date and more than one year from the exercise date. Meeting both makes the sale a qualifying disposition eligible for long-term capital-gains treatment on the whole gain.
Are ISOs taxed at exercise?
Not for regular tax if you hold the shares — but the spread is an AMT preference item at exercise, so a large exercise-and-hold can still produce a tax bill via AMT.
In Formation
AMT-aware equity planning
See this in your own numbers.
Formation organizes your whole household by entity and cites every figure to its source — the context that makes terms like this actionable.
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