Can You Reduce ISO Tax via a Trust? Revocable vs. Living Trust

Someone on Reddit had heard that a trust (e.g., revocable trust or living trust) can reduce the tax on exercising Incentive Stock Options (ISOs) and wanted to know whether that is possible and how to set it up. A revocable trust or living trust generally does not reduce your income tax or AMT when you exercise ISOs. Revocable and living trusts are typically grantor trusts: you (the grantor) are still treated as the owner for income tax purposes, so you remain liable for tax on the exercise and for AMT on the spread. A revocable trust can help with estate planning (e.g., avoiding probate, controlling how assets pass), but it does not by itself change the tax consequences of the ISO exercise.

Bottom line: A revocable trust or living trust generally does not reduce your income tax or AMT when you exercise ISOs. Revocable and living trusts are grantor trusts: you are still treated as the owner of the trust's income and assets for tax purposes, so income, gains, and AMT from the trust are reported on your return. Putting ISO shares (or the exercise) into a revocable trust does not move the ISO exercise or the shares "outside" your tax picture. A revocable trust can still be useful for estate planning (probate avoidance, control at death), just not for ISO tax. For any strategy that involves transferring options or shares to a trust to shift tax, consult a tax professional and an estate planning attorney; confirm plan rules, gift and estate tax effects, and income tax/AMT for you vs. the trust or beneficiary.

Question from Reddit

Reducing tax on ISO exercise via a trust?

I've heard that it's possible to reduce your ISO tax burden via a trust. I'd imagine this would have to be with a revocable trust or living trust? Does anyone know if this is possible, and how such a plan would have to be setup?

Source: Reddit

Analysis

The user has heard that a trust (e.g., revocable or living trust) can reduce the tax on exercising Incentive Stock Options (ISOs) and wants to know whether that is possible and how to set it up. Using a trust to cut income tax or AMT on an ISO exercise depends on who is taxed on the exercise and who owns the options/shares. Revocable and living trusts are typically grantor trusts: the grantor (you) is still treated as the owner for income tax purposes, so you remain liable for tax on the exercise and for AMT on the spread. Putting ISO shares (or the exercise) into a revocable trust does not, by itself, change or eliminate that tax.

Answer

Short answer: A revocable trust or living trust generally does not reduce your income tax or AMT when you exercise ISOs. It can help with estate planning (e.g., avoiding probate, controlling how assets pass at death), but it does not by itself change the tax consequences of the ISO exercise.

Why a revocable trust doesn't change ISO tax

Revocable trusts (and many living trusts) are grantor trusts for federal income tax. That means you, as the grantor, are still treated as the owner of the trust's income and assets for tax purposes. So:
- Income, gains, and AMT from the trust are reported on your return.
- If you exercise ISOs and the shares (or the options) are held in or transferred to a revocable trust, the exercise is still attributed to you. You still have AMT on the spread (FMV at exercise minus exercise price) and the same income tax when you sell (qualifying vs. disqualifying disposition).
Because you retain control (revocable = you can change or revoke it), the assets are also still part of your estate for estate tax purposes. So a revocable trust does not move the ISO exercise or the shares "outside" your tax picture.

What a revocable trust can do

Estate planning: Avoid probate, control who gets what and when, and organize how assets are managed during life and at death. None of that reduces the income tax or AMT due when you exercise the ISOs or when you sell the shares.

Other trust ideas (and limits)

Irrevocable trusts: Transferring options or shares to an irrevocable trust (e.g., for a spouse or children) can shift future gain or income to the trust or beneficiaries, but that usually involves giving up control and can trigger gift tax (and generation-skipping tax, if applicable). The employer's plan may not allow transfer of ISOs to a trust (or to anyone else) before exercise; many plans restrict transfer. So "reducing ISO tax via a trust" often isn't as simple as moving the options into a trust.
Charitable trusts (e.g., CRTs, CLTs) can be used in estate or charitable planning and may offer income or estate tax benefits in other contexts, but they are not a standard way to eliminate or reduce the AMT or income tax on an ISO exercise for the employee. They also require you to give away benefits to charity.

What to do

Don't rely on a revocable or living trust to reduce ISO exercise tax or AMT. Plan for the exercise and AMT as you normally would (e.g., estimate AMT, set aside funds, time the exercise if possible).
If you are interested in estate planning (probate avoidance, control at death), a revocable trust can still be useful, just not for ISO tax.
For any strategy that involves transferring options or ISO shares to a trust or other person (e.g., to shift tax), you need to confirm: (1) plan rules (can you transfer?), (2) gift tax and estate tax effects, and (3) income tax and AMT for you vs. the trust/beneficiary. That requires a tax professional and often an estate planning attorney.
Margen can help you model the AMT and income tax from an ISO exercise so you know the real "burden" and can plan cash flow and timing; it doesn't set up a trust.

Applicable Sections

Federal / IRS

Grantor trust rules: Revocable trusts are generally grantor trusts (IRC §§ 676, 677); income and gains are taxed to the grantor, so putting ISO shares in a revocable trust does not shift income tax or AMT away from you.
ISO and AMT: IRC § 422 (ISOs); IRC § 56(b)(3) (AMT preference for ISO exercise spread). The tax follows the taxpayer who exercises and holds the shares; a grantor trust does not change that when you are the grantor.
Publication 525: Taxable and Nontaxable Income; discusses stock options, including ISOs and AMT. (IRS Publication 525)

Estate / gift tax

Gift tax may apply if you transfer options or shares to a trust (or other person) for less than full value; estate tax still includes revocable trust assets in your estate. An estate planning attorney or tax advisor can address gift and estate tax.

Practical Notes

Revocable / living trust: Does not reduce income tax or AMT on ISO exercise; you are still the grantor and are taxed on the exercise and any sale.
Revocable trust can still be useful for estate planning (probate, control), just not for ISO tax.
Transferring options or shares to an irrevocable trust can have gift tax and plan implications; employer plan may not allow transfer. Get tax and legal advice before doing it.
Margen can help you model ISO exercise AMT and tax so you plan for the real burden.
Consult a tax professional and, if you are considering any trust, an estate planning attorney for strategies that fit your situation.

Limitations

This answer does not cover specific irrevocable trust designs, employer plan transfer rules, or state trust/estate law. It is not legal or tax advice. For whether any trust can reduce your ISO tax in your situation, consult a tax advisor and an estate planning attorney. Margen can help you model the tax impact of an ISO exercise before or after you talk to them.

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Can You Reduce ISO Tax via a Trust? Revocable vs. Living Trust (Reddit Q&A)