Equity compensation · Section 422
ISO taxes wait until you sell, but exercising can trigger the AMT.
You owe no regular income tax when you receive or exercise an incentive stock option (ISO) under Section 422. Hold the shares 2 years from grant and 1 year from exercise, and the whole gain is long-term capital gain. If you exercise vested shares and hold them past that year’s end, the spread counts as income for the alternative minimum tax (AMT). The spread is what the shares were worth at exercise, minus what you paid.
Updated · Sources
Federal ISO rules for 2026
- 2 years
- must pass from the grant date before the whole gain can be long-term capital gain.
- 1 year
- must also pass from exercise, or the spread is taxed as wages, usually up to your gain on the sale.
- $100K
- of stock, valued at grant, can first become exercisable under ISOs in a calendar year.
For 2026 the AMT exemption is $90,100 for single filers and $140,200 for joint filers. It phases out above $500,000 of AMT income, or $1,000,000 for joint filers.
Do your options get ISO tax treatment?
You get the full ISO tax benefits only if these five tests hold, along with the plan rules below. Options that fail one of the first four are generally taxed as non-qualified stock options (NSOs).
An employee on the grant date
ISO tax treatment is only for employees. On the grant date, you must be an employee of the company that grants the option, or of its parent or subsidiary. Contractors, advisors and non-employee directors cannot receive ISOs.
An exercise price at fair market value
The exercise price must be at least the stock’s fair market value on the grant date. If you own more than 10% of the voting power, the price must be at least 110% of that value. A more-than-10% owner’s options must also expire within 5 years of grant.
Within the $100,000 limit
If options on more than $100,000 of stock first become exercisable in one calendar year, the options over that amount are taxed as NSOs. The stock is valued on the grant date. The limit counts every plan of your employer and its parent and subsidiaries. It does not cap how much you can be granted or exercise.
Exercised within 3 months of leaving
You must exercise while employed, or within 3 months after you leave. Exercise later, if your plan allows it, and the option is taxed as an NSO. The window is 1 year if you left because of a permanent and total disability. If you die while employed, or within 3 months of leaving, your estate or heirs can exercise without this deadline.
Held 2 years from grant and 1 year from exercise
Selling or giving away the shares before both dates have passed is a disqualifying disposition. The spread at exercise then counts as wages in the year you sell, capped at your gain on an arm’s-length sale. A transfer to your spouse, or to a former spouse in a divorce, is not a disposition.
The plan itself must also meet Section 422’s rules, such as stockholder approval within 12 months and a 10-year limit on each option.
An ISO taxation example: when you sell decides the tax.
Sold within 1 year of exercise
$69,640
A disqualifying sale. The $100,000 spread is taxed as wages at 37%, and the other $80,000 as short-term gain at 37% plus 3.8%.
Sold after 1 year, within 2 years of grant
$56,040
A disqualifying sale, because 2 years have not passed since grant. The spread is taxed as wages at 37%, and the other $80,000 as long-term gain at 20% plus 3.8%.
Sold after both holding periods
$42,840
A qualifying sale. The whole $180,000 is long-term gain, taxed at 20% plus 3.8%.
These figures use top federal rates: 37% on wages and short-term gain, and 20% on long-term gain. At these income levels, you also owe the 3.8% net investment income tax on the capital gain. That tax applies only when modified AGI is above $200,000, or $250,000 for joint filers. No Social Security or Medicare tax is due on the wage part. Holding past year end can also add AMT for the exercise year. State tax is separate. To use this as a rough ISO tax calculator, swap in your own amounts and rates.
ISO and NSO stock options are taxed at different times.
An NSO’s spread is taxed as wages the day you exercise. An ISO’s spread owes no regular tax until you sell, though it can count for the AMT.
| NSO | ISO | |
|---|---|---|
| At exercise | Spread taxed as wages | No regular tax |
| Payroll tax | Social Security and Medicare | None Even after an early sale |
| AMT | No adjustment | Spread counts If you hold the shares past year end |
| At sale | Capital gain above the exercise-date value Long-term if held more than 1 year | All long-term capital gain If held long enough |
| Reported on | Form W-2, code V in box 12 For employees | Form 3921 And W-2 box 1 after an early sale |
The ISO tax implications people miss.
The AMT is due before you sell
If you exercise vested shares and hold them past year end, you can owe AMT for that year before selling a single share. Cover it with estimated tax payments or extra withholding that year, or an underpayment penalty can apply.
The price falls after you exercise
The AMT counts the shares’ value on the exercise date, even if the price later falls. If you sell before that year ends, the AMT adjustment goes away and your wage income is capped at your actual gain. A wash sale (buying the shares back within 30 days) or a sale to a related person loses that cap. If you hold longer, AMT you paid returns only as a credit, capped each year at your regular tax minus your tentative minimum tax.
The 1099-B basis is too low
Your ISO cost basis is the exercise price you paid. After a disqualifying sale, your basis also includes the income taxed as wages. For options granted after 2013, the 1099-B leaves that income out, so you fix the basis on Form 8949. Otherwise the same income is taxed twice.
No withholding is required on an early sale
The wages from a disqualifying sale belong in box 1 of your W-2, but your employer does not have to withhold tax on them. If the W-2 leaves them out, you report them yourself on Schedule 1. Set the tax aside when you sell.
The AMT basis is left out
Shares you exercise and hold have a second, higher basis for the AMT: the exercise price plus the spread. Use it on Form 6251, line 2k, in the year you sell, or the AMT counts the spread again.
You exercised before the shares vested
If you exercise unvested shares, the AMT waits until they vest and uses their value then. An 83(b) election filed within 30 days of exercise counts the spread at exercise, which is zero if you paid fair market value. The election has no effect on your regular tax.
ISO planning before you exercise.
Valim’s CPAs help startup employees plan ISO exercises around the AMT, and file the returns that follow.
- We model the AMT before you exercise, and find how many shares you can exercise before it starts.
- We weigh an early exercise with an 83(b) election, which can keep the AMT spread at zero.
- We time your sale around the holding periods and any liquidity event, such as a tender offer or IPO.
- We handle the ISO tax reporting: the AMT on Form 6251, and your basis on Form 8949 when you sell.
- We claim your AMT credit on Form 8801 in the later years you can use it.
- Individual return
- from $195
- Business return
- from $495
We quote a flat fee before work starts. We do not bill hourly.
ISO tax questions.
What does ISO mean on taxes?
ISO stands for incentive stock option, an employee stock option that meets the rules of Section 422. You owe no regular income tax when you receive or exercise one. Keep the shares 2 years from grant and 1 year from exercise, and your whole gain is long-term capital gain. If you exercise vested shares and hold them past year end, the alternative minimum tax counts the spread at exercise as income.
What is the $100,000 ISO limit?
The $100,000 ISO limit caps the stock, valued at grant, that can first become exercisable as ISOs in one calendar year. That is usually the year the options vest. Every plan of your employer, its parent and its subsidiaries counts toward it. Options over it still work, but they are taxed as non-qualified stock options. If options on $150,000 of stock, valued at grant, first vest in one year, $100,000 of them are ISOs and $50,000 are NSOs.
How do I calculate ISO tax?
To calculate ISO tax, start with the spread: fair market value at exercise, minus the exercise price, times the shares. If you exercised vested shares and still hold them at year end, the spread goes on Form 6251, line 2i. You owe AMT only if your tentative minimum tax (your tax figured under the AMT rules) comes out above your regular tax. After a qualifying sale, your whole gain above the exercise price is long-term capital gain. After an early sale, the spread (usually capped at your gain) is taxed as wages, and the rest is capital gain.
Do ISOs trigger the AMT?
ISOs can trigger the AMT when you exercise vested shares and still hold them at year end. The spread then counts as AMT income, and you owe AMT if your tax under the AMT rules exceeds your regular tax. For 2026 the AMT exemption is $90,100 for single filers and $140,200 for married couples filing jointly. It shrinks by 50 cents for each dollar of AMT income above $500,000, or $1,000,000 for joint filers. If you exercise vested shares and sell them in the same year, there is no AMT adjustment.
What is Form 3921?
Form 3921 is the information return your company files for each ISO exercise, with a copy to you. It shows the grant and exercise dates, the exercise price and fair market value per share, and the shares transferred. You should get it by January 31 after the year you exercise, or the next business day if that falls on a weekend. You keep it with your records rather than file it with your return. You enter its figures in TurboTax, or give them to your CPA, to work out any AMT adjustment and, later, your gain.
Sources
- 26 U.S.C. § 422, Incentive stock options
- 26 U.S.C. § 421, General rules for statutory stock options
- 26 U.S.C. § 56, Adjustments in computing alternative minimum taxable income
- 26 U.S.C. § 55, Alternative minimum tax imposed
- 26 U.S.C. § 53, Credit for prior year minimum tax liability
- 26 U.S.C. § 424, Definitions and special rules
- 26 U.S.C. § 3121, Definitions (FICA wages)
- 26 U.S.C. § 6654, Failure by individual to pay estimated income tax
- Treas. Reg. § 1.422-1, Incentive stock options, general rules
- Treas. Reg. § 1.422-4, $100,000 limitation for incentive stock options
- Treas. Reg. § 1.83-2, Election to include in gross income in year of transfer
- Rev. Proc. 2025-32, inflation adjustments for 2026
- IRS, Instructions for Form 6251 (2025)
- IRS, Instructions for Form 3921 and 3922
- IRS, Instructions for Form 8949 (2025)
- IRS, General Instructions for Forms W-2 and W-3 (2026)
- IRS Pub. 525 (2025), Taxable and Nontaxable Income
Reviewed and updated September 2026. General information, not advice for your situation.