A California startup employee exercises ISOs with a $300,000 spread on top of $300,000 in salary. The ISO spread is her AMT preference item — $300,000 of Alternative Minimum Taxable Income not visible on her regular return. Below the $500,000 OBBBA phaseout threshold, the full $90,100 exemption applies: taxable AMTI is $209,900. Federal AMT at 26%: approximately $54,600. California AMT adds approximately $21,000. Combined: over $75,000, due in April, on shares she cannot sell. The phaseout zone is new in 2026. The same exercise with any additional ISO spread pushing AMTI above $500,000 would have entered the phaseout zone under OBBBA — a band that did not exist at the same income level under 2025 law, and which phases out twice as fast.
What changed about ISO AMT in 2026 under the OBBBA?
The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, made two simultaneous AMT changes effective in 2026: it lowered the exemption phaseout threshold to $500,000 for single filers and $1,000,000 for married filers (down from approximately $626,350 and $1,252,700 under prior law), and it doubled the phaseout rate from 25 cents to 50 cents for every dollar of AMTI above those thresholds. The exemption — $90,100 for single filers, $140,200 for MFJ — is gone entirely at $680,200 for single filers and $1,280,400 for MFJ filers.
The 2026 AMT exemption amounts themselves were increased slightly and made permanent. The exemption figures cited here ($90,100 single / $140,200 MFJ) are confirmed against IRS Revenue Procedure 2025-32, which published the official inflation-adjusted 2026 amounts.
Who Has This Problem
You are directly affected if:
- You hold ISOs at a California startup, pre-IPO company, or recently public firm with unexercised options whose combined annual income — salary, bonus, and other sources — approaches or exceeds $500,000 as a single filer or $1,000,000 married filing jointly.
- You planned your 2026 ISO exercise strategy based on pre-OBBBA thresholds, which were significantly higher and phased out more slowly.
- You work at SpaceX, Anthropic, Databricks, Crusoe, or any other pre-IPO company where exercise timing relative to the S-1 filing date also affects your QSBS holding period.
How ISO Exercises Trigger AMT
The federal alternative minimum tax under IRC §55 runs parallel to regular income tax. You calculate both and pay whichever is higher. For most W-2 employees, regular tax wins. ISO exercises change that.
When you exercise an ISO and hold the shares past December 31, the bargain element — the spread between the stock’s fair market value at exercise and your strike price — becomes an Alternative Minimum Tax preference item under IRC §56(b)(3). It does not appear on your W-2. It generates no ordinary income. It is invisible on your regular return and produces phantom income: a tax obligation on gains that exist only on paper, owed whether or not you sold a share.
Inside the Phaseout Zone: Why the Effective Rate Is 42%, Not 28%
AMT applies at 26% on AMTI up to a threshold and 28% above it. The 28% rate sounds manageable — but inside the OBBBA phaseout zone, the effective marginal cost of additional ISO spread is higher because exercising additional shares simultaneously triggers more AMT while reducing the available exemption.
The math: at the 28% AMT rate, every additional dollar of AMTI above the $500,000 phaseout threshold costs 28 cents in AMT. But the phaseout simultaneously reduces your exemption by 50 cents, exposing an additional 50 cents of previously sheltered AMTI to tax. That additional 50 cents, taxed at 28%, adds another 14 cents. The combined marginal cost inside the phaseout zone: 28 + 14 = 42 cents per dollar. That is the effective 42% rate — not a statutory rate, but the real cost of additional ISO spread for taxpayers in the phaseout band.
AMTI and AMT Exemption Comparison
| AMTI Level (Single) | AMT Exemption Remaining | Effective Marginal Rate |
| Below $500,000 | $90,100 (full) | 26% or 28% on AMTI above exemption |
| 500,001–680,200 | Shrinking at 50 cents/dollar | ~42% effective |
| Above $680,200 | $0 (fully phased out) | 26% or 28% on full AMTI |
The California AMT Layer
California imposes its own AMT at 7% on California AMT income. California’s phaseout thresholds and calculation methods differ from the federal OBBBA changes in several respects. A California founder who calculates only federal AMT will underpay California.
California also adds back the SALT deduction for AMT purposes — just as the federal AMT does. A California employee who deducts $40,000 in California state income taxes on her regular return must add the full $40,000 back to compute AMTI, both for federal and California AMT. With the OBBBA also increasing the regular-tax SALT cap, some taxpayers will face a counter-intuitive result: more SALT deductible for regular tax, but that additional SALT still must be added back for AMT, increasing AMTI and the phaseout exposure.
Four ISO Exercise Strategies for 2026
Strategy 1: Stay Below the Phaseout Threshold
If your AMTI before any ISO exercise is below $500,000 as a single filer, exercising shares that keep total AMTI below $500,000 preserves the full $90,100 exemption. For a single filer with $350,000 in salary and no other AMT preferences, AMTI before ISO exercise is approximately $260,000 after adjustments. Room to the $500,000 threshold: approximately $240,000 in ISO spread. At a $25 spread per share, that allows exercising approximately 9,600 shares this year without entering the phaseout zone. Run this calculation before any exercise.
Best for: founders and employees with AMTI below $500,000 single who can calibrate exercise quantity.
Strategy 2: Split the Exercise Across December and January
Exercising shares in late December and the remainder in early January applies the full $90,100 exemption in each of two tax years, doubling the available shelter. A single filer who exercises $90,000 in spread in December and $90,000 in January can shelter $180,000 in ISO spread from AMT — at zero additional cost beyond the timing adjustment.
Best for: founders who want to exercise more than the single-year threshold allows without entering the phaseout zone.
Strategy 3: Exercise Early When the Spread Is Small
The AMT preference item is the spread at the moment of exercise. Exercising options when the 409A value is $2 per share produces a far smaller AMT preference than exercising when the 409A is $20. Early exercise — often combined with an §83(b) election on unvested shares — is the most effective long-term AMT strategy because it front-loads the exercise to the point of smallest spread.
Best for: founders at early-stage companies where the 409A value is still low. This strategy cannot be applied retroactively.
Strategy 4: Same-Day Sale When Illiquidity Risk Is Unacceptable
Holding ISO shares after exercise creates phantom income AMT exposure. If the company is private and the shares cannot be sold, or if the stock price may decline before a liquidity event, a same-day sale converts the exercise into a disqualifying disposition — ordinary income at exercise on the spread, reported on your W-2 as compensation, with no AMT preference and no phantom income problem. The downside: ordinary income rates, which can reach 53% combined for a California employee in the highest federal bracket, exceed the AMT rates in most cases. But if shares subsequently lose value, the same-day sale eliminates the risk of paying AMT on gains that later disappear.
Best for: founders and employees at companies where post-exercise stock price decline is a real risk or where liquidity is uncertain.
A Decision Guide
Which strategy fits your situation:
| If Your AMTI (Including Exercise) Will Be… | Start With… |
| Below $500,000 single / $1,000,000 MFJ | Strategy 1: Exercise up to the threshold. No phaseout, full exemption. |
| 500,000–680,200 single / 1,000,000–1,280,400 MFJ | Strategy 1 + 2: Calibrate to threshold, split remainder to next year. |
| Above $680,200 single / $1,280,400 MFJ | Model all four strategies. At this exemption level, the California AMT credit trap and QSBS holding period interaction are the primary planning variables. |
| Private company, stock price uncertain | Strategy 4 as a baseline, then evaluate the after-tax cost of qualifying hold vs. same-day sale. |
The California AMT Credit Trap for Founders Planning to Relocate
AMT paid on ISO exercises generates a Minimum Tax Credit under IRC §53, carried forward and applied against regular federal tax in future years. This credit is eventually recoverable — if you remain a California taxpayer.
A California founder who exercises ISOs, pays California AMT in 2024, then relocates to Texas in 2025, generates a California AMT credit that can only be applied against California tax. As a Texas resident with no California-source income, that credit sits on the California return indefinitely — unrecoverable. If you are a California founder who is planning to relocate after a liquidity event and is currently evaluating ISO exercises, the California AMT credit trap is a material variable that changes the exercise timing analysis.
The ISO and QSBS Interaction — Updated for OBBBA
For founders holding stock in a qualifying C-corporation, the ISO exercise date starts two clocks simultaneously: the §422 qualifying disposition clock (one year from exercise, two years from grant) and the §1202 QSBS holding period clock.
For stock issued after July 4, 2025, the OBBBA introduced a tiered QSBS exclusion: 50% after 3 years, 75% after 4 years, 100% after 5 years, with a $15 million gain exclusion cap (increased from $10 million under prior law). This is a significant change from the prior all-or-nothing five-year cliff. For a founder who exercises ISOs on post-July 4, 2025 stock and files an §83(b) election on any unvested portion, the three-year 50% exclusion becomes available three years from the grant date — not five. Early exercise, combined with an §83(b) election, can compress the timeline to the first QSBS benefit window by two full years.
For stock issued on or before July 4, 2025, the old rules still apply: five-year hold required, $10 million exclusion cap, $50 million gross asset threshold. California does not conform to the QSBS exclusion regardless of when the stock was issued.
What Capital Tax Does
Capital Tax models the federal and California AMT exposure for each client’s proposed ISO exercise, incorporating the 2026 OBBBA phaseout thresholds, the SALT add-back, the client’s total income, and the multi-year AMT credit recovery timeline. We model the exercise quantity and timing that minimizes total tax over a three-to-five year horizon, accounting for the QSBS tiered holding period interaction and the California AMT credit trap for clients planning departure.
Begin Your ISO Exercise and AMT Analysis
If you hold ISOs at a California startup and are considering exercising in 2026, model your federal and California AMT exposure before pulling the trigger. The OBBBA phaseout changes mean the safe exercise quantity in 2026 is lower than it was in 2025 for most high earners. Begin your ISO Exercise and AMT Analysis at capitaltax.com/pre-ipo-stock-comp.
AMT on ISO exercises is due in April with no withholding and no employer notification. There is no automatic extension.
Frequently Asked Questions About ISO Exercise
1. How does exercising ISOs trigger AMT in 2026?
When you exercise Incentive Stock Options (ISOs) and hold the shares beyond December 31, the difference between the fair market value and the exercise price becomes an Alternative Minimum Tax (AMT) preference item. This can increase your Alternative Minimum Taxable Income (AMTI) and create an additional tax liability even if you have not sold the shares.
2. What are the 2026 AMT exemption amounts for single and married filers?
For 2026, the AMT exemption amounts discussed in this guide are $90,100 for single filers and $140,200 for married filing jointly (MFJ). The exemption begins phasing out when AMTI exceeds $500,000 for single filers and $1,000,000 for married filers.
3. How did the OBBBA change ISO AMT in 2026?
The One Big Beautiful Bill Act (OBBBA) lowered the AMT exemption phaseout thresholds to $500,000 for single filers and $1,000,000 for married filing jointly. It also increased the phaseout rate from 25 cents to 50 cents for every dollar of AMTI above the applicable threshold.
4. What is the effective 42% AMT rate for ISO exercises?
The effective 42% marginal rate applies within the OBBBA AMT exemption phaseout zone when the 28% AMT rate applies. The additional 14% comes from the reduction in the AMT exemption, which exposes more income to AMT.
5. Does California have a separate AMT on ISO exercises?
Yes. California imposes its own Alternative Minimum Tax on qualifying income, including ISO-related AMT adjustments. California has separate phaseout thresholds and calculation methods, so employees exercising ISOs should evaluate both federal and California AMT exposure.
6. How can I reduce AMT exposure when exercising ISOs?
Potential strategies include staying below the AMT exemption phaseout threshold, splitting exercises across December and January, exercising early when the stock spread is smaller, and evaluating a same-day sale when liquidity or stock-price risk is a concern.
7. How does an ISO exercise affect the QSBS holding period?
For qualifying stock, exercising ISOs can start the Section 1202 Qualified Small Business Stock (QSBS) holding period. The timing of the exercise and applicable QSBS rules can influence when a founder may qualify for potential capital gains exclusions.
8. What happens to California AMT credits if I relocate to another state?
California AMT credits may become difficult to recover after relocating. For example, a California founder who moves to Texas without California-source income may have difficulty using accumulated California AMT credits against future tax liabilities. Relocation plans should therefore be considered when evaluating ISO exercise timing.