Incentive Stock Options

A Note Before We Begin

If you have ever accepted a job offer that included “stock options,” you may have felt a flickering of excitement, followed quickly by a feeling of confusion. You are not alone! Equity can be one of the most valuable parts of a compensation package and one of the least understood. A decision made without a plan, or made too late, can cost real money. A thoughtful decision can make a meaningful difference in your family’s financial picture.

This article walks through one type of stock option, the incentive stock option (“ISO”) and items of consideration for planning with them.

What is an Incentive Stock Option (ISO)?

Think of an ISO at its core as just an option – the opportunity to buy a stock at a specific price (or strike price), no matter what the stock is worth when you decide to exercise (use) it. If the shares of the stock become worth more than your strike price, the option is valuable (also referred to as in-the-money). If the stock stays flat or falls, you simply don’t use it as there is no imbedded value in the option.

Most employer-provided options vest, meaning you gain the right to exercise them gradually over months or years, depending on the plan. Vesting schedules vary significantly from company to company, and this structure encourages employees to stay. ISOs specifically can come with meaningful tax advantages when certain conditions are met.

There are two main kinds of employer-provided stock options. The first, a non-qualified stock option (NQSO), is simpler but less tax-advantaged. With NQSOs, you typically owe tax both when you buy the shares and when you sell them, which usually means a larger tax bill than with the second kind – incentive stock options (ISOs).

A few features set ISOs apart from NQSOs:

• Only employees can receive them. Consultants and contract workers can receive only the non-qualified kind.
• The strike price must be at least the stock’s value on the day the option is granted.
• They expire no later than 10 years after they’re granted.
• Only $100,000 worth of ISOs (measured by the stock’s value at grant) can first become usable (or vest) in any single year. Anything above that is treated like the less favorable kind (NQSOs).

How Common are ISOs?

More common than you might think, especially outside the large public companies. Roughly three-quarters of private companies offer stock options, and about 60% grant ISOs, rising to just over 80% among private companies in Silicon Valley and startups. In 2024, more than half of initial equity grants to executives at private-equity and venture-backed companies were ISOs. ¹

Younger, pre-IPO companies tend to favor ISOs but this can become less common as a company matures and approaches a public offering. That means many people holding ISOs work at, or recently left, growth-stage companies.

Who Typically Receives ISOs?

You will most often find ISOs in the hands of:

• Employees of startups and growing private companies, where stock stands in for a bigger salary. At about half of private companies that offer options, more than 80% of employees receive them.
• Engineers, salespeople, managers and executives hired in the early years.
• Employees of recently public companies who still hold older grants.

How are ISOs Taxed? A Simple Example

The big appeal of ISOs is when and how you are taxed, best illustrated by an example.

Marcy’s company grants her options to buy 1,000 shares at $5 per share. Years later, the shares are worth $25 each, and she decides to buy them (or exercise). The $20 difference per share, or $20,000 in total, is called the bargain element or spread.

• When you receive and vest options: No tax due
• When you exercise: No regular income tax is owed, even though Marcy now holds shares worth $20,000 more than she paid. (There is an important exception, called the AMT, discussed below).
• When you sell: If Marcy holds the shares for more than one year after buying them and more than two years after the original grant, her entire profit is taxed at the lower long-term capital gains rate. If she sells sooner, the “bargain element” portion is generally taxed as ordinary income, like a paycheck, which is usually a higher rate.

In short, patience is rewarded, but it also carries risk: the longer you hold a single company’s stock, the more exposed you are if its price falls.

Should You Exercise or Wait?

The right answer depends on your finances, your company and your goals. Here are the main trade-offs.

• Exercise and sell right away. This is the simplest path. You lock in your gain and avoid the risk of holding a single company’s stock. The trade-off is that you give up the ISO tax advantage, and the profit is generally taxed as ordinary income. If you exercise and sell in the same year, the AMT issue discussed below generally does not apply.
• Exercise and hold. This path can earn you the lower long-term capital gain tax rate, but it requires cash to buy the shares and may trigger additional tax along the way. If the stock then drops, you could end up owing tax on gains you never realized.
• Wait. Holding off preserves your cash and flexibility, but the clock keeps ticking toward expiration, and a bigger gain later can mean a bigger tax bill.
• Spread it out. Many people exercise a portion each year, buying only as many shares as they can afford without an unnecessarily large tax bill.

If your company is private, there is often an extra wrinkle – you may be paying real cash for shares you cannot sell yet. That is a meaningful risk to weigh.

Watch the Calendar: Expiration Dates

ISOs run on two clocks.

1. The overall expiration date. ISOs can last no more than 10 years. That sounds like a long time, but companies are staying private for longer. If a company remains private beyond the option’s term, employees would need to buy the shares while it is still private or lose the value of their options entirely.
2. The “departure” deadline. If you leave your employer, you generally have only about 90 days to exercise (current law’s outer limit for keeping ISO status is three months, or 12 months in cases of disability). Many people don’t realize this until they have already resigned or been laid off. Some companies offer longer windows, but extending the deadline can change the tax treatment.

Mark both dates on your calendar the day you receive a grant.

The Potential Complication Called the AMT

Most people have never heard of the Alternative Minimum Tax (AMT), but if you hold ISOs, it is worth knowing. The AMT is a second, parallel way of calculating your tax. You pay whichever calculation produces the higher bill. Taxpayers subjected to AMT have become exceedingly rare post the 2017 TCJA and however with 2025 OBBBA, there is a chance that more individuals may be subject to this tax with compressed phase out ranges.

Why does this matter? Remember Marcy’s $20,000 spread – for regular tax purposes, it’s invisible when she exercises. But for AMT purposes, that difference gets added to her income and the stock’s value at exercise becomes her starting point (her “AMT basis”) for figuring AMT gain or loss on a later sale. If the spread is large, it can push someone into paying AMT, even though they have not sold a single share.

The good news:

• Exemptions shield many people. For 2026, the AMT exemption is $90,100 for single filers and $140,200 for married couples filing jointly.
• Higher earners lose some of that protection. The exemption begins to shrink at $500,000 of AMT income for single filers and $1,000,000 for married couples filing jointly, and recent changes (as described above) have caused it to shrink twice as fast as it used to. ²
• AMT paid can often be recovered later. Taxes paid because of this timing difference typically generate a credit that can be used against future regular taxes, though it can take years to use up.

Because the numbers get complicated quickly, this is an area where advance planning pays off. Running the math before you exercise is far better than discovering the bill the following April.

What To Do Next

If you hold or expect to receive ISOs, a few simple steps can help:

1. Find your grant paperwork and note the strike price, vesting schedule and expiration date.
2. Learn what happens to your options if you leave, including the deadline to exercise.
3. If your plan allows early exercise (buying shares before they vest), ask whether an 83(b) election makes sense for you. The election must be filed within 30 days of exercise.
4. Consider how much of your net worth is tied to a single company
5. Talk with your client centric team and tax professional before you exercise, not after.

Stock options can be a wonderful opportunity to build wealth, and proper planning helps make sure your decisions are well timed. If you would like to talk through your own situation, we are here to help.

Sources:

1. Tayan, B., Larcker, D., & Watts, E. (2021, August 26). Stock-option financing in Pre-IPO Companies. The Harvard Law School Forum on Corporate Governance. https://corpgov.law.harvard.edu/2021/08/26/stock-option-financing-in-pre-ipo-companies/
2. 2026 Tax brackets. (2025, October 10). Tax Foundation. https://taxfoundation.org/data/all/federal/2026-tax-brackets/

This article is for educational purposes only and is not tax, legal, or investment advice. Please consult your tax professional about your individual circumstances.