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By Aaron Skloff, AIF, CFA, MBA / August 4, 2015. UPDATED March 2026 Via Claude AI
Q: My employer has awarded me numerous stock options over the years. When can I exercise these employee stock options and what are the tax ramifications?
A: The Problem. Many employers award stock options to attract and retain employees. Unfortunately, many employees do not truly understand the different types of options they are awarded, their tax ramifications and how their terms can change.
The Solution – Understanding Employee Stock Options. An employee stock option is a right, but not a requirement, to purchase a stock at a specific price and specific time. Before you can exercise your options they must vest. Vesting is the right to buy shares from your employer over a set period of time, as defined in your grant agreement, before the options expire. Not all employee stock options are created equal. Those differences could leave you quite wealthy and the I.R.S. disappointed or leave you somewhat wealthy and the I.R.S. happy. Let’s look at both types of options.
Incentive Stock Options (ISOs). In general, you do not have to pay taxes on Incentive Stock Options (ISOs) under the regular federal tax system when they are exercised. To qualify for the most favorable tax treatment, the sale must be more than one year from the exercise date and more than two years from the grant date — known as a “qualified disposition.” Charles Schwab If both conditions are met, your gain is taxed at long-term capital gains rates rather than ordinary income rates.
Long-term capital gains are taxed at 0%, 15%, or 20% depending on your total taxable income Bankrate, compared to ordinary income tax rates that currently range from 10% to 37%. Bankrate
Important Note on AMT: When you exercise ISOs and hold the shares, the spread at exercise is income for the Alternative Minimum Tax (AMT) calculation — even though it is not taxable under the regular federal tax system. Darrow Wealth Management For 2025, the AMT exemption is $88,100 for single filers and $137,000 for joint filers. Kitces Starting in 2026, the One Big Beautiful Bill permanently locks in higher AMT exemption levels, but the phaseout rate doubles from 25% to 50%, meaning high earners lose the exemption more quickly — creating a new “AMT cliff” for those with significant ISO exercises. Vipwealthadvisors Speak with your Financial Advisor before exercising your options.
ISO Example. On July 1, 2022, you receive an ISO giving you the right to purchase 100 shares of ABC stock for $10 per share. You exercise your ISO on August 2, 2023, when the market price is $15. Your cost basis per share becomes $10. On September 3, 2024, you sell your ABC stock for $30 a share. The date of sale is more than two years after the July 1, 2022, grant date and more than one year after the August 2, 2023, exercise date. By meeting both conditions, your $2,000 profit ($30 × 100 shares – $10 × 100 shares) is a long-term capital gain, eligible for the 0%, 15%, or 20% long-term capital gains rate depending on your total taxable income.
Nonqualified Stock Options (NQSOs). With NSOs, you pay ordinary income tax on the spread — the difference between the exercise price and the fair market value — at the time of exercise. Carta Short-term capital gains (assets held for one year or less) are taxed at ordinary income tax rates ranging from 10% to 37%. Kiplinger If you hold the stock for more than one year before selling, long-term capital gains rates of 0%, 15%, or 20% apply NerdWallet, depending on your taxable income.
NQSO Example. On July 1, 2022, you receive an NQSO giving you the right to purchase 100 shares of ABC stock for $10 per share. You exercise your NQSO on August 2, 2023, when the market price is $15. You are now subject to ordinary income tax rates (up to 37%) on the $500 gain ($15 × 100 shares – $10 × 100 shares). Your cost basis per share becomes $15. On September 3, 2024, you sell your ABC stock for $30 a share. The sale date is more than one year after the August 2, 2023 exercise date, making the additional gain eligible for the long-term capital gains rate of 0%, 15%, or 20% based on your total taxable income.
ISOs are generally more attractive than NQSOs, since they do not generate ordinary income taxes when they are exercised. That said, the two-year wait might occur when the stock price is in a downward spiral — and the AMT rules add complexity. Don’t Let the Tax Tail Wag the Investment Dog. Although tax management is critical, it is not paramount to maximizing profit.
Expiration Dates. Since options are often awarded at different times they have different expiration dates. A very valuable option leading up to its expiration date is worthless the day after its expiration date. So, exercise diligence when exercising your options.
Often Overlooked. Many stock option plans have clear language defining your rights about exercising your options upon termination from the company. For example, upon termination (other than by reason of death or disability) you may have up to 90 days from the date of termination to exercise all or any part of your options that were exercisable at the date of termination. Severance from a job can be an emotional time, when you may overlook a material part of your wealth — your employee stock options.
Action Step – Understand Your Options
Work closely with your Financial Advisor to understand and manage your employee stock options.
Note: Tax laws change frequently. The figures above reflect current rates as of 2025–2026, including changes made by the One Big Beautiful Bill signed in July 2025. Always consult a qualified tax advisor before making exercise or sale decisions.
Aaron Skloff, Accredited Investment Fiduciary (AIF), Chartered Financial Analyst (CFA), Master of Business Administration (MBA) is CEO of Skloff Financial Group, a Registered Investment Advisory firm specializing in financial planning, investment management and benefits for small to middle sized companies. He can be contacted at www.skloff.com or 908-464-3060.