By Harry Prabandham · Updated September 27, 2026
Equity Compensation
ISOs vs NSOs: How Stock Option Taxes Differ
NSO spreads are taxed as wages at exercise; ISO spreads skip regular tax but can trigger AMT, and qualify for long-term rates if holding periods are met.
ISOs vs NSOs: How Stock Option Taxes Differ
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What is the difference between ISOs and NSOs?
- Both give the right to buy company shares at a fixed strike price; the difference is how the spread is taxed.
- NSOs: the spread at exercise is ordinary wage income, subject to withholding and payroll taxes.
- ISOs: no regular income tax at exercise, but the spread counts for the alternative minimum tax, and meeting holding periods makes the whole gain long-term.
- ISOs can go only to employees and are subject to a $100,000 annual limit; NSOs can go to employees, contractors, advisors, and directors.
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Full Guide
What is the difference between ISOs and NSOs?
- Both give the right to buy company shares at a fixed strike price; the difference is how the spread is taxed.
- NSOs: the spread at exercise is ordinary wage income, subject to withholding and payroll taxes.
- ISOs: no regular income tax at exercise, but the spread counts for the alternative minimum tax, and meeting holding periods makes the whole gain long-term.
- ISOs can go only to employees and are subject to a $100,000 annual limit; NSOs can go to employees, contractors, advisors, and directors.
How are ISOs and NSOs taxed at exercise?
- The NSO spread is reported as W-2 wages with 22% federal supplemental withholding, or 37% above $1 million, in 2026, plus Social Security up to $184,500 and Medicare.
- Flat 22% withholding often falls short for high earners, so a balance due at filing is common.
- The ISO spread carries no regular income tax and no FICA, but it is an AMT adjustment in the year of exercise if you hold the shares past year-end.
- For 2026, the AMT exemption is $90,100 single and $140,200 joint, phasing out at 50 cents per dollar above $500,000 and $1,000,000; the 28% rate applies above $244,500.
How are ISO and NSO shares taxed when sold?
- NSO shares take a basis equal to the strike plus the taxed spread; later gain or loss is capital, long-term if held more than one year after exercise.
- An ISO qualifying disposition requires holding 2 years from grant and 1 year from exercise; the entire gain over the strike is then long-term capital gain.
- In a disqualifying disposition, ordinary income is generally the lesser of the spread at exercise or the actual gain, with no FICA.
- AMT paid because of an ISO exercise can create a minimum tax credit that may be recovered in later years.
What is the ISO $100,000 rule?
- Only $100,000 of ISOs, measured by the grant-date value of the underlying shares, can first become exercisable in a calendar year; the excess is treated as NSOs.
- Grants that allow early exercise count in the year the options first become exercisable.
- ISOs must be exercised within three months of leaving employment, or one year after disability, to keep ISO status.
- For holders of more than 10% of the company, the strike must be at least 110% of fair market value and the term no more than five years.
Exercise strategy differences
- ISO holders often exercise in tranches across tax years to keep the spread under the point where AMT begins.
- Early exercise with an 83(b) election when the spread is small starts the holding-period clock and can reduce AMT, but risks paying for shares that later lose value.
- NSO holders often focus on timing: exercising in lower-income years, or exercising and selling to cover taxes and reduce concentration.
- A same-day or cashless sale of ISO shares is a disqualifying disposition, taxed like an NSO exercise without payroll tax.
Typical recipients, and when ISOs become NSOs
- Private companies commonly grant ISOs to employees, while public companies and grants to non-employees tend to use NSOs.
- ISOs automatically become NSOs when the $100,000 limit is exceeded or the post-termination window passes, even if the grant letter says ISO.
- Company extensions of the exercise window after you leave generally convert ISOs to NSOs for tax purposes.
Key takeaways
- NSOs produce predictable ordinary income at exercise; ISOs defer regular tax but can create AMT and require holding periods.
- The 2026 AMT exemption and phase-out figures set how much ISO spread can be exercised before AMT applies.
- Neither type is inherently more favorable; the result depends on price risk, liquidity, income, and state taxes.
- Model exercises with a CPA before acting; Rubric does not prepare tax returns.
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