Non-qualified stock options (NSOs) are taxed as ordinary income on the spread when you exercise, whether or not you sell. Incentive stock options (ISOs) owe no regular income tax at exercise, but the spread counts for the alternative minimum tax (AMT), and the gain is taxed as long-term capital gain only if you hold the shares long enough. When to exercise depends on the type of option, the company's outlook, your cash, and what else is on your tax return that year.
What is the difference between an ISO and an NSO?
Both give you the right to buy company shares at a fixed price, the strike price. The difference is in how the tax code treats them.
- NSOs can be granted to employees, directors, advisors and contractors. At exercise, the spread between market value and strike price is ordinary income, reported on your W-2 if you are an employee, with payroll tax and withholding.
- ISOs can only be granted to employees and must meet rules in section 422 of the tax code. Only the first $100,000 of ISOs, measured by grant-date value, that become exercisable in one year get ISO treatment. The rest are treated as NSOs.
How are NSOs taxed?
At exercise, the spread is ordinary income. Your employer usually withholds federal tax at the 22% supplemental rate on the first $1 million of supplemental pay in a year, and 37% above that. For many high earners, 22% is below their real bracket, so the gap shows up in April. After exercise, any further gain or loss is capital, long-term if you hold the shares more than a year.
How are ISOs taxed?
At exercise, no regular income tax and no payroll tax. If you then hold the shares more than two years from the grant date and more than one year from exercise, the whole gain from strike price to sale price is long-term capital gain. That is a qualifying disposition.
Sell earlier, and it is a disqualifying disposition: the spread at exercise, or the actual gain if smaller, becomes ordinary income, and the rest is capital gain.
An ISO trades a certain tax today for an uncertain one later, through the AMT.
Where does the AMT come in?
The spread on ISOs you exercise and hold past year end is added to income for the alternative minimum tax. If your AMT calculation exceeds your regular tax, you pay the difference. The AMT paid on ISOs can often be recovered as a credit in later years, but not always quickly.
The July 2025 federal tax law changed the AMT for 2026, lowering the income at which the AMT exemption starts to phase out and speeding up that phase-out. For some ISO holders, that means AMT starts at a smaller exercise than in 2025. For 2026, the exemption is $90,100 for single filers and $140,200 for married couples filing jointly. It phases out by 50 cents for each dollar of alternative minimum taxable income above $500,000 for single filers and $1,000,000 for joint filers, so it is gone at $680,200 and $1,280,400 (IRS, Rev. Proc. 2025-32, October 2025).
Utah has no alternative minimum tax. Its individual income tax is one flat rate on state taxable income, which starts from federal adjusted gross income (Utah Code sections 59-10-103 and 59-10-104, current as of October 2026). An ISO exercise and hold is an AMT item, not regular income, so it does not create Utah income in the year of exercise. Utah taxes the gain when you sell. A disqualifying disposition creates ordinary income in federal adjusted gross income, so Utah taxes that too.
What about early exercise and the 83(b) election?
Some private companies let you exercise before your options vest. You then own restricted stock. If you file an 83(b) election with the IRS within 30 days of exercise, you are taxed on the spread at that moment, which may be zero if the strike price equals current value, and the clock for long-term treatment starts. The risk is that you pay for shares, and possibly tax, on stock that may never be worth anything or that you lose if you leave before vesting.
What shapes the timing?
- Expiration. Options expire, often ten years after grant, and usually within about 90 days after you leave the company. ISOs not exercised within three months of leaving lose ISO status.
- Cash. Exercising costs the strike price, and possibly tax, before you can sell. For private companies, there may be no way to sell for years.
- Concentration. Exercising and holding adds to a position in the same company that pays your salary.
- The rest of the return. A year with low other income may leave room for NSO income or ISO spread before higher brackets or the AMT apply.
- Spreading exercises. Exercising in pieces across several tax years can keep each year's income or AMT exposure smaller.
A hypothetical example
Hypothetical. An employee at a Utah tech company holds both ISOs and NSOs. The company is private, with a possible sale in a few years. One approach would exercise a slice of ISOs each December, sized to stay under the point where AMT begins, and hold the NSOs until a sale, when they would be exercised and sold the same day. Another would exercise everything now to start the holding clock. The first spreads the tax and the risk. The second bets more on the company. Which is right depends on the employee's cash, the company's prospects and how much of the household's wealth is already tied to it.
Silicon Slopes has made stock options a normal part of pay in Utah. Our page on equity compensation covers how RSUs, NSOs and ISOs fit into a household's tax year, and why a projection in the payout year matters.
Educational only. Not investment, tax, or legal advice. Every situation is different; the right answer depends on the numbers, and that's what the strategy session is for. Investing involves risk, including possible loss of principal.