If you’re like most of our clients working in tech, there’s a good chance you’ve got stock options… but you’re not exactly sure what to do with them. Or even what they are.
You log into your equity portal, see a bunch of letters and numbers, and suddenly you’re supposed to make big financial decisions. But you’re not totally sure what those decisions are – or what they mean for your taxes.
This is super common. And it’s totally understandable.
One of the biggest problems we see is that people don’t know what type of stock options they have. And that makes it almost impossible to understand the tax side, ISO vs NSO, or what your strategy should be.
Let’s fix that.
We’ll walk you through the two main types of stock options, how they’re taxed, and how we help clients use different strategies depending on what they’re working with.
Let’s start with step one.
Step One: Figure Out What Kind of Stock Options You Have
The two types of stock options you’re most likely to see are:
- NSOs: Nonqualified Stock Options
- ISOs: Incentive Stock Options
It’s easy to check which one you have. Log into your equity portal—Carta, Shareworks, E*TRADE, Fidelity, or whatever your company uses—and look at the grant details.
You’re looking for the abbreviation: NSO or ISO.
Once you know which one you’re working with, you can start to understand how they behave differently.
What NSOs and ISOs Have in Common
No matter which one you have, all stock option grants come with a few key things:
- A grant date (when the options were issued)
- A number of options
- A vesting schedule (when the shares become available to exercise)
- An exercise price, also called the strike price (the amount you’ll pay to buy each share)
Here’s why that matters.
Let’s say your exercise price is $2. And the stock is now worth $12. That $10 difference is called the bargain element.
If you have 1,000 shares, your bargain element is $10,000.
That $10,000 is what the IRS cares about.
This is where the two types of options start to behave differently—especially when it comes to taxes.
How NSO Taxes Work
If you have NSOs, the tax rule is pretty simple:
When you exercise, the bargain element is treated as ordinary income. It gets added to your W-2, just like a bonus. And your company is required to withhold taxes when you exercise.
So let’s go back to that $10,000 example. If you exercise 1,000 NSO shares at a $10 bargain, you’re reporting $10,000 of extra income. That gets taxed at your normal income rate.
That’s why most people exercise and sell NSOs at the same time. You generate the cash from the sale and use some of it to pay the taxes. Clean and simple.
How ISO Taxes Work
Incentive Stock Options are different.
When you exercise ISOs, you don’t owe any regular income tax at that moment. Nothing shows up on your W-2. It might seem like you’re in the clear.
But this is where something called AMT comes into play.
Wait – What Is AMT?
AMT stands for Alternative Minimum Tax. It’s a separate tax system the IRS uses to make sure people with certain types of income—like large ISO exercises—still pay their fair share, even if their regular tax return shows zero due.
The IRS looks at the bargain element from your ISO exercise and says:
“We’re not going to tax you now under regular rules, but under AMT, this $10,000 bargain element counts as income.”
So even though nothing shows up on your W-2, you could still owe tax under the AMT system, especially if you exercise a lot of shares or the stock price is high.
This catches a lot of people off guard. And there’s no withholding. So if you trigger AMT, you need to plan ahead and make sure you have the cash to pay it.
One More ISO Rule to Know: The $100,000 Limit
With ISOs, there’s also a rule that says you can’t have more than $100,000 worth of ISOs vest in one year (based on their exercise price). If you do, the excess gets treated as NSOs automatically.
Just something to be aware of if you’re at a high-growth company with a big grant.
So… What Should You Do?
We approach these differently depending on what you have.
With NSOs, the most common strategy we use is: Wait for your target price, then exercise and sell right away.
You’ll know your tax bill, you’ll have the cash to cover it, and it’s simple to track.
With ISOs, we usually start with: Exercise and hold.
This lets you aim for long-term capital gains (which are usually taxed at a lower rate). But we always look at AMT. If AMT is going to hit hard, we plan around it—maybe by exercising in smaller chunks or selling early to avoid a cash crunch.
And just to be clear: it’s totally okay to sell your ISOs right after exercising. That’s called a disqualifying disposition, and it just means you won’t get long-term tax treatment. It might still be the smartest move depending on your goals. Every one’s plan is different; there can be more important things than trying to save money on taxes in the future.
If You Have Both ISOs and NSOs
This is where things get really interesting—and where planning matters most.
Let’s say you have both NSOs and ISOs. One of our favorite strategies looks like this:
- Exercise and sell some NSOs to generate cash and increase your ordinary income
- Then exercise and hold some ISOs
Why do this?
Because the extra income from the NSOs can reduce how much AMT you owe on your ISO exercise. And the cash from selling the NSOs can be used to pay the AMT, if you still owe anything at all.
We do this kind of coordination with clients all the time. It’s one of the most powerful ways to make your stock options work for you instead of catching you by surprise.
You Don’t Have to Figure This Out Alone
Stock options are one of the biggest financial opportunities you’ll ever have.
But they can also be one of the most confusing parts of your compensation.
If you’re not sure what to do – or even what you have – don’t try to guess your way through it. This is exactly the kind of thing we help clients with every day.
Go to kbfinancialadvisors.com, click the green button in the top right corner, and book a call with us. We’ll walk through your grants, figure out what you’re working with, and help you make a plan that actually fits your life.
Want to learn a little more first? Check out our post on Understanding Stock Options where we break this stuff down in plain English.
We’re here to help!
Until next time!
