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Cash Flow with Incentive Stock Option Exercise (Dynjandi Waterfall, Iceland)

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A Quick Note from Iceland

Hey everybody, this is Robbie with Matterhorn Financial Planning. I’m here on a rainy Icelandic day at a waterfall whose name I can’t pronounce—I'll have to put it in the notes for you. It’s beautiful in this country.

A Tip on Incentive Stock Options

I want to share another tip about your incentive stock options—something important that people sometimes forget about: cash flow.

When you're exercising your options, including Incentive Stock Options (ISOs), you need to be mindful of the option cost you pay upfront. This means you may need to have cash on hand for that cost.

Cashless Exercise Options

You may also have the option of doing a cashless exercise, which is totally fine. Whether you use your own cash or go the cashless route, either way works.

However, what you really need to keep in mind is the amount of Alternative Minimum Tax (AMT) you might have to pay in the first year before you sell the stock.

The AMT Catch

Here's how it works:

  • You're exercising the stock and holding it, but for AMT purposes, you've recognized income.

  • That means you're creating a tax liability to the IRS.

  • Ideally, you’ll get that money back through the AMT credit, but the catch is this:

    You haven’t actually generated any cash for yourself, yet you may owe a significant tax bill.

Depending on how much you exercise, this tax amount could be tens of thousands—I’ve seen it even reach hundreds of thousands of dollars.

Timing and Planning are Critical

If you're going to exercise ISOs and hold them, before you do it, and before the end of the calendar year, make sure:

  • You’re doing tax projections.

  • You have a concept of how much cash you’ll need by April.

  • You know whether you'll have enough funds to pay it.

Avoiding Financial Strain

Otherwise, you could put yourself in a tough spot:

  • You might have to borrow money to pay your taxes.

  • You might need to go on a payment plan with the IRS.

Neither of these scenarios is ideal.

Final Advice

Watch your cash flow—not just for the exercise price, but particularly:

  • Get a projection in place.

  • Know how much AMT you may need to pay.

  • Ideally, do all this before you exercise, so you know exactly what you're getting into.

Thanks.