ISOs and the AMT in 2026: The Exemption Now Disappears Twice as Fast

If you hold incentive stock options at a startup or a newly public company, the decision you make about exercising them is usually a decision about the alternative minimum tax — not about the options themselves. That has been true for years. What's new is that the arithmetic changed on January 1, 2026, and it changed in the direction that costs you money.

The 2025 tax law — the "One Big Beautiful Bill Act," or OBBBA — made the larger AMT exemption permanent, which was the good news everyone reported. It also did something that got much less attention: it lowered the income level where that exemption starts to disappear, and doubled the speed at which it disappears. Both changes took effect for tax years beginning after December 31, 2025. If you ran an ISO exercise through a calculator in 2024 or 2025 and filed the result away, the number you got is no longer the number.

Why ISOs and the AMT collide in the first place

A quick refresher — for the full picture on how ISOs, NSOs, and RSUs each work, see our guide to equity compensation.

When you exercise an ISO, you generally recognize no income for regular tax purposes. That's the whole appeal. But for AMT purposes, the spread — the fair market value of the shares at exercise minus what you paid — is an adjustment in the year you exercise. It shows up on its own line of Form 6251 (line 2i, "Exercise of incentive stock options"), and it can be large enough to make your tentative minimum tax exceed your regular tax. The difference is the AMT you write a check for.

The reason this feels unfair is that in a private company there is usually no cash and no market. You've paid the strike price out of pocket, you're holding shares you generally can't sell, and now you owe tax on a gain that exists only on a 409A valuation report. If the company later stumbles, you've paid real tax on paper value that never materialized.

There is a compensating mechanic, and it matters: after an ISO exercise you carry two bases in the same shares. Your regular-tax basis is what you paid. Your AMT basis is what you paid plus the spread you already picked up as an AMT adjustment. When you eventually sell, the AMT gain is generally smaller than the regular gain — which is part of how the AMT you paid comes back to you later. More on that below.

What actually changed for 2026

The AMT gives you an exemption — an amount of alternative minimum taxable income (AMTI) that is simply excluded. Above a threshold, that exemption phases out. OBBBA reset both the threshold and the phase-out rate. These are the figures from the IRS's annual inflation adjustments (Rev. Proc. 2024-40 for 2025 and Rev. Proc. 2025-32 for 2026), and they're mirrored on the 2026 draft Form 6251:

Read the last two rows again, because that's the whole story. The exemption amounts themselves went up slightly with inflation. But a single filer's exemption is now completely gone by $680,200 of AMTI instead of $978,750 — nearly $300,000 earlier. For a joint filer it's gone by $1,280,400 instead of $1,800,700, more than $500,000 earlier. An ISO exercise is exactly the kind of item that pushes AMTI into that compressed zone in a single year.

Two rate details worth keeping straight: the AMT rate is 26% on the first $244,500 of the AMT base ($122,250 if married filing separately) and 28% above that for 2026. And that $244,500 breakpoint applies to the base after the exemption, not to AMTI.

What this looks like on an actual return

Take a single filer with $260,000 of W-2 wages, no other income, taking the standard deduction ($16,100 for 2026). She holds 40,000 vested ISOs with a $1.00 strike price, and the current 409A value is $9.00 — an $8.00 spread per share.

Without exercising: taxable income is $243,900 and her regular federal tax is about $54,504. No AMT.

If she exercises all 40,000 shares: the spread is $320,000. Her regular tax doesn't move — the exercise is invisible to the regular system. But her AMTI becomes roughly $580,000, and the AMT machinery runs like this:

• AMTI of $580,000 is $80,000 over the $500,000 threshold, so she loses 50¢ on the dollar — $40,000 of exemption. Her exemption drops from $90,100 to $50,100.
• AMT base: $580,000 − $50,100 = $529,900.
• Tentative minimum tax at 28% (less the $4,890 adjustment for the 26% portion): about $143,482.
• AMT owed = tentative minimum tax − regular tax = $143,482 − $54,504 = about $88,978.

So the exercise costs roughly $89,000 in federal tax, on top of the $40,000 she spent on strike price, for shares she generally cannot sell. Her total federal tax for the year goes from about $54,500 to about $143,500.

The 2026 rules are responsible for a real slice of that. At the same $580,000 of AMTI under the 2025 threshold of $626,350, the phase-out wouldn't have started at all — she'd have kept the full exemption. That $40,000 of lost exemption is worth about $11,200 of additional tax, purely from the rule change, on identical facts.

How much can you exercise before AMT starts?

This is the number most people actually want, and it's often called the AMT crossover point: the amount of ISO spread you can recognize before your tentative minimum tax catches up to your regular tax. Below it, exercising costs you nothing in current tax. Above it, every dollar of spread has a price.

For the filer above, the crossover lands at roughly $39,700 of spread — about 4,900 shares at her $8.00 spread. She could exercise about 12% of her position this year for no federal AMT at all, then repeat the exercise next January.

Your own crossover will be different, and it's genuinely sensitive to the inputs: other income, filing status, whether you itemize, capital gains, and any other AMT adjustments all move it. It also moves during the year as your company's valuation changes. Treat any figure you get from an online calculator as a starting point for a conversation, not an answer.

The levers you actually control

• Exercise in tranches, across calendar years. The crossover resets each January. Spreading exercises over two or three years is usually the difference between a manageable plan and a surprise.
• Exercise early in the year, not in December. This buys you an escape hatch. If you exercise and the stock falls, selling the shares in the same calendar year means, per the Form 6251 instructions, that the regular tax and AMT treatment are the same and no AMT adjustment is required. You give up ISO treatment — it becomes a disqualifying disposition, and the gain measured at sale is generally taxed as ordinary compensation income — but you avoid paying AMT on value that evaporated. It's a fallback, not a strategy, and it disappears on December 31.
• Check whether your "ISOs" are all really ISOs. Under §422(d), to the extent the aggregate fair market value of stock for which ISOs become first exercisable in a calendar year exceeds $100,000, the excess is treated as a nonstatutory option. That value is measured at grant, not at vesting. Fast-vesting grants at companies that have appreciated often exceed it, so part of what your equity portal labels "ISO" may already be an NSO — which has no AMT adjustment but does create ordinary income at exercise.
• Mind the three-month window if you leave. Under §422(a)(2), you generally must have been an employee from grant until within three months of exercise. Exercise later than that and the option is generally taxed as an NSO. (Different rules apply if employment ended because of death or disability.) Departing employees with a short post-termination exercise window are making an AMT decision and a cash decision at the same time, on a deadline.
• Know where you already sit. If a large exercise has already pushed you past the top of the phase-out band, additional spread generally costs 28% rather than 42%. That doesn't make more exercise a good idea, but it does mean the marginal cost of the next tranche isn't always what people assume.
• If your plan allows early exercise, the analysis is different. Exercising unvested shares and filing an 83(b) election within 30 days of the transfer of the shares generally fixes the AMT measurement at the exercise-date spread — which, right after a grant, is often near zero. This is a narrow, time-limited opportunity with real downside if the company fails, and relief for a missed election is limited. Don't do it on your own read of a blog post.

One more practical point: the AMT you owe from a March exercise generally has to be funded through the estimated-tax system, not just at filing. A large exercise can create an estimated tax obligation and an underpayment penalty that has nothing to do with whether you file on time.

The AMT credit: real, but slower than people expect

ISO spread is what the rules call a deferral item — a timing difference, not a permanent one. AMT generated by deferral items creates a minimum tax credit under §53, claimed on Form 8801, that carries forward indefinitely.

The catch is in how it's released. The credit is generally usable in a later year only to the extent your regular tax exceeds your tentative minimum tax in that year. For individuals it is not refundable — you can't simply request the money back. So someone who paid $89,000 of AMT on an exercise may recover it over several years, or may recover very little of it for a long time if their income stays in territory where AMT keeps applying. The steeper 2026 phase-out cuts in this direction too: a compressed exemption makes tentative minimum tax higher in later years, which is exactly when you'd want it low so the credit can be used.

The dual basis helps here. When you sell the shares, your AMT gain is measured from the higher AMT basis, which generally produces a negative AMT adjustment in the sale year and helps free up the credit. It's a real recovery mechanism — it just runs on the tax system's timetable rather than yours.

Two things that widen the gap in 2026

The bigger SALT deduction doesn't help you here. OBBBA raised the state and local tax deduction cap substantially for 2025 through 2029 (about $40,400 for 2026, phasing down for high earners and floored at $10,000). That's a genuine benefit against regular tax — and it does nothing for AMT, because state and local taxes are added back in full when computing AMTI (Form 6251 line 2a). Anything that lowers your regular tax while leaving AMTI untouched widens the gap between the two systems, and the gap is what AMT actually taxes. For anyone with a large state and local tax bill — New Jersey, New York, and California residents especially — the SALT add-back is one of the mechanical reasons the two calculations diverge as much as they do.

Your state may run its own AMT. A handful of states impose an individual alternative minimum tax, and California's is the one this audience runs into most often — an ISO exercise is generally an adjustment there as well. New Jersey and New York do not impose an individual AMT, so for most of our clients the exposure here is federal. Confirm your own state's treatment before planning around the federal number alone, particularly if you've moved during the year.

The bottom line

The ISO rules themselves are unchanged for 2026. What changed is the container they sit in: the AMT exemption now starts phasing out at $500,000 of AMTI for single filers and $1,000,000 for joint filers, and it phases out twice as fast. The practical consequences are that the exercise you could do "for free" is smaller than it was, the expensive middle band is more expensive, and the credit you're relying on to get the money back may take longer to release.

None of that argues against exercising. It argues for deciding how much and when deliberately, with the current year's numbers, before December — not after a year-end exercise has already fixed the outcome.

Frequently asked questions

I exercised ISOs earlier this year and the stock has since dropped. Is there anything I can do?

Possibly, if it's still the same calendar year. Selling the shares in the year you exercised generally means the regular tax and AMT treatment match, so no AMT adjustment is required for that exercise. The tradeoff is that it's a disqualifying disposition: you lose ISO treatment, and the spread measured at sale is generally taxed as ordinary compensation income rather than capital gain.

Whether that's better than holding depends on how far the stock fell, whether you have the cash to pay AMT on the paper gain, and what you believe about the company. It's a decision worth running the numbers on well before December 31, because the option closes then.

Should I just exercise everything now while the strike price looks cheap?

Rarely, and almost never in one year. Exercising the full position generally means paying the strike price in cash plus AMT on the entire spread, for shares in a company that may not have a market for years. The more common approach is to exercise up to your crossover point each year, and to size any exercise above that against how much tax you're willing to pay for an outcome you can't control.

The one factor that legitimately pushes toward exercising sooner is a rising 409A valuation — waiting generally makes the spread, and therefore the AMT, larger.

Is it ever better for an option to be treated as an NSO instead of an ISO?

Sometimes, yes. An NSO exercise creates ordinary compensation income immediately, but for a current employee it's generally withheld on at exercise, it generates no AMT adjustment, and it gives you a known cost rather than a phantom tax bill. Employees who intend to exercise and sell in the same transaction — at a tender offer or after an IPO lockup expires — often find ISO treatment adds complexity without delivering the long-term capital gain benefit it exists for.

Will I actually get the AMT I pay back?

Generally some of it, eventually, but not on a schedule you control. AMT from an ISO exercise creates a minimum tax credit that carries forward indefinitely, and it's released in later years only to the extent your regular tax exceeds your tentative minimum tax. It isn't refundable for individuals. Plan the exercise as though the cash is gone for several years, and treat the credit as an upside rather than a funding source.

Does it matter whether I exercise in January or December?

It matters a great deal. A January exercise gives you eleven months to watch the company, keeps the same-year-sale fallback available if things go badly, and starts the one-year holding-period clock earlier. A December exercise locks in the AMT adjustment with no room to react. Both start the same holding period requirements — more than two years from grant and more than one year from the transfer of the shares for a qualifying disposition — but only one of them leaves you options.

This article is general educational information, not individualized tax advice. Please consult a qualified tax professional about your own situation before making decisions.