Exercise and taxes

Maya worked at a startup for three years. She has 50,000 vested options with a $2 strike price, and the 409A value is now $10 a share. She resigns on Friday. In 90 days, her options expire. To keep them, she must pay $100,000. She can also owe tax on a $400,000 spread, for shares that she cannot sell. How did a good grant become a hard choice? This lesson explains the exercise and the tax that comes with it.

How you exercise

To exercise means to buy the shares that your options give you, at the strike price. Usually you send an exercise notice through the company’s cap table software, and you pay. The company then issues the shares to you. There are three ways to pay:

Cash exercise. You pay the strike price with your own money. This is the usual way at a private company.
Net exercise. The company keeps some of the shares to pay the strike price. For example, you exercise 1,000 options at $2 when a share is worth $10. The company keeps 200 shares, and you get 800. Not all plans let you do this.
Same-day sale. You exercise and sell at the same time. A buyer pays for the shares, and the strike price comes out of the sale money. This is possible only when a buyer exists, for example at an IPO or in a tender offer.

For example, a tender offer buys shares at $8.00. An employee with 20,000 vested options at a $0.40 strike price exercises and sells on the same day. She gets 20,000 × ($8.00 − $0.40) = $152,000 before tax. The tax on this money is usually ordinary income tax.

The tax when you exercise

The tax depends on the type of option. The spread is the base for the two types: the fair market value on the day you exercise, minus the strike price, times the options.

With an NSO, the spread is ordinary income, the same as salary. It is income in the year that you exercise, even if you keep the shares. For an employee, the company usually withholds tax at the exercise, and Social Security and Medicare tax also apply.

With an ISO, the spread adds no regular income tax. But the spread counts as income for a second tax calculation, the alternative minimum tax, or AMT.

How the AMT works

The AMT is a parallel calculation of your federal tax. You calculate your regular tax, and you calculate a second tax, the tentative minimum tax. You pay the larger of the two. The difference is the AMT. For tax year 2026, the second calculation uses these numbers:

The exemption is $90,100 for a single filer and $140,200 for a married couple who file jointly.
The exemption decreases by 50 cents for each dollar of AMT income over $500,000 (single) or $1,000,000 (joint).
The rate is 26% on the first $244,500 after the exemption, and 28% on the part that is more than $244,500.

An ISO spread goes into the AMT income, but not into the regular taxable income. Thus a large ISO exercise can make the tentative minimum tax larger than the regular tax.

Predict first

A single employee earns a $150,000 salary in 2026, takes the standard deduction, and has no other income. She exercises ISOs with a $160,000 spread and keeps the shares. How much more federal tax does she owe because of the exercise?

Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.

Worked example · step 1 of 5

The AMT on a $160,000 ISO spread in 2026

1
Find the spread
The employee exercises 40,000 ISOs with a $1 strike price when the 409A value is $5.
```
Spread = ($5 − $1) × 40,000 = $160,000
Strike = $1 × 40,000       = $40,000
```

The same exercise as NSOs adds $46,900 of federal income tax, because the $160,000 is ordinary income at her top rates. Thus the ISO is cheaper here, but it is not free.

The AMT on ISOs usually gives you an AMT credit that you can use against your regular tax in later years. That credit helps later. It does not help you pay the AMT this year.

Exercise some ISOs each year with no AMT

The AMT starts only when the tentative minimum tax becomes larger than the regular tax. Thus each year, you can exercise ISOs up to a spread with no AMT. For the employee in the example, the AMT-free spread is approximately $35,231:

26% × ($150,000 + spread − $90,100) = $24,734
spread                              = $35,231
At a $4 spread for each option: $35,231 ÷ $4 = 8,807 options

The calculator shows this amount for your own salary. Change the option type, the salary, and the fair market value. Look at where the ISO line starts to rise.

Calculator

The tax on an option exercise in 2026

Enter your salary and the exercise. See the federal tax and the cash that the exercise needs this year.

Option type

Filing status

Salary this year

Options to exercise

Strike price

Fair market value (409A price)

The value of one common share on the day you exercise.

Cash for the strike: $40,000; 40,000 × $1.00
Spread: $160,000; 40,000 × $4.00
Extra federal tax: $32,440; All of it is AMT
Cash needed: $72,440; Strike plus tax, this year

Extra federal tax by the number of options you exercise

As ISOs (AMT)
As NSOs

As ISOs, the $160,000 spread adds no regular income tax, but it counts for the AMT. Your AMT is $32,440. With the strike, you need $72,440 in cash this year, for shares that you cannot sell yet.

With this salary, you can exercise approximately 8,807 options (a $35,231 spread) this year before the AMT starts. As NSOs, the same exercise adds $46,900 of tax.

The tax when you sell

When you sell the shares, the tax depends on how long you held them. With ISOs, the important dates are the grant date and the exercise date:

If you sell more than 2 years after the grant and more than 1 year after the exercise, the sale is a qualifying disposition. All of the gain over the strike price is long-term capital gain.
If you sell earlier, the sale is a disqualifying disposition. The spread at exercise becomes ordinary income, but this income cannot be more than your gain on the sale.

With NSOs, you already paid ordinary income tax on the spread at exercise. When you sell, the increase in value after the exercise is a capital gain. It is long-term if you held the shares for more than 1 year.

The $100,000 ISO limit

Each calendar year, only $100,000 of options, at their grant-date value, can become exercisable for the first time as ISOs. The part over $100,000 becomes NSOs. This is the $100,000 ISO limit.

For example, a grant has 200,000 options at a $2.00 grant-date value, which is $400,000. If 50,000 options vest each year for 4 years, each year adds $100,000, and all options are ISOs. A grant of 300,000 options at $2.00 vests $150,000 each year. Thus 25,000 options each year ($50,000) are NSOs.

When you leave: the 90-day window

When you leave a company, your unvested options go back to the pool. Your vested options usually expire 90 days after your last day. This limit is the post-termination exercise period. The 90-day default comes from the ISO rule: to keep ISO treatment, you must exercise within 3 months after your employment stops. The limit is 1 year if you leave because of a disability.

Thus at the end of a job, you must make a decision with little time. You can exercise all of your vested options, exercise some of them, or let them expire. To exercise, you pay the strike price and the tax, for shares that you usually cannot sell.

Work it out

Maya leaves with 50,000 vested options at a $2 strike price. The 409A value is $10. How much cash does she need for the strike price alone?

Work it out

What is the spread on Maya's 50,000 options? This is the amount that counts for the AMT (as ISOs) or for income tax (as NSOs).

Longer windows

Some companies give a longer window to employees who leave. DLA Piper gave two examples in August 2016. Pinterest and Quora let employees with 2 or more years of service exercise vested options for up to 7 years after they left. Ask about the window before you accept an offer.

A longer window has a limit. The tax law does not change with the company’s plan. The IRS taxes an ISO that you exercise more than 3 months after you leave as an NSO. Thus a longer window gives you time, but your ISOs become NSOs for tax.

Early exercise and the 83(b) election

Some companies let you exercise options before they vest. This is early exercise. You then own restricted stock. If you leave before the shares vest, the company can buy back the unvested shares at the price that you paid.

Early exercise lets you pay tax when the spread is small. You file an 83(b) election with the IRS within 30 days after the exercise. The election tells the IRS to tax the spread on the day you exercise. If you exercise immediately after the grant, the strike price equals the fair market value, so the spread and the tax are $0.

For example, you get 100,000 options at a $0.10 strike price when the fair market value is $0.10. On the first day, you pay $10,000 and file an 83(b) election. The spread is $0, so the tax is $0. If you wait and exercise when the value is $5, the spread is $490,000. If you exercise early but do not file the election, the spread on each part counts for tax when that part vests.

The election also starts two clocks early:

The holding period for long-term capital gains starts on the day you exercise.
The QSBS holding period starts on that day too. For stock that you get after July 4, 2025, QSBS can exclude 50% of the gain after 3 years and 75% after 4 years. After 5 years, it can exclude 100%. The limit is the larger of $15M or 10 times your basis.

Without an 83(b) election, these holding periods start only as each part vests. The lesson on QSBS gives the rules.

Early exercise has a cost. You pay cash for shares that can become worthless. If the company fails, you do not get the $10,000 back. Also, all of an early-exercisable ISO grant becomes exercisable in the first year. If the grant is worth more than $100,000 at the grant date, only $100,000 of it stays ISOs, and the rest are NSOs.

The lesson on the 83(b) election shows the same election for founder shares.

Quiz · question 1 of 6

Test what you learned

You exercise ISOs with a $160,000 spread in 2026 and keep the shares. What is the federal tax treatment?

In this lesson you will learn