Stock Options: Exercise Cost, Spread, and Tax for NSOs vs. ISOs
October 29, 2026
Employee stock options give you the right to buy company shares at a fixed strike price. The spread is the difference between the share's fair market value and the strike price. If you hold 1,000 options with a strike of $5 and the shares are worth $20, the spread is ($20 − $5) × 1,000 = $15,000. To exercise, you need cash for the purchase: $5 × 1,000 = $5,000, plus taxes in many cases.
There are two main types in the US. Nonqualified stock options (NSOs) are taxed as ordinary income on the spread at exercise. Incentive stock options (ISOs) get special treatment: no regular tax at exercise, but the spread is an adjustment for the alternative minimum tax (AMT), and a qualifying sale (more than 2 years after grant and 1 year after exercise) is taxed entirely as long-term capital gains.
Skip the math and get your answer instantly:
Open the Capital Gains Calculator →NSO Example
At exercise, the $15,000 spread is ordinary income. At a 24% federal bracket, the federal tax is $3,600 (plus Medicare and possibly state tax). Cash needed at exercise: $5,000 + $3,600 = $8,600 (for an employee, the tax is often withheld from the proceeds or through a sell-to-cover). The cost basis of the shares becomes $20. If you later sell at $30 after holding more than a year, the long-term gain is ($30 − $20) × 1,000 = $10,000, taxed at 15% = $1,500. Total taxes: $5,100 on a total profit of $25,000, leaving $19,900.
| Item | NSO | ISO (qualifying sale) |
|---|---|---|
| Exercise cost | $5,000 | $5,000 |
| Tax at exercise | $3,600 (24% of $15,000) | $0 regular (AMT may apply) |
| Sale price | $30 | $30 |
| Total profit before tax | $25,000 | $25,000 |
| Tax on sale | $1,500 | $3,750 (15% of $25,000) |
| Total tax | $5,100 | $3,750 |
| After-tax profit | $19,900 | $21,250 |
ISO Considerations
With ISOs, the $15,000 spread is not taxed as regular income at exercise, which allows more of the profit to be taxed at the lower long-term capital gains rate: $25,000 × 15% = $3,750. But the spread counts for the AMT calculation, and could trigger AMT in the year of exercise even though you haven't sold any shares. If you sell before meeting the holding periods (a disqualifying disposition), the spread at exercise is taxed as ordinary income similar to an NSO. For private company options, you may owe tax with no way to sell, a serious cash flow problem.
Decisions and Risks
Exercising early starts the capital gains holding period and may reduce taxes but requires cash and takes a risk: if the stock falls to $2, you've paid $5,000 plus taxes for shares worth $2,000. Consider the vesting schedule, the expiration date (options typically expire 10 years after grant, and 90 days after leaving the company), the company's prospects, and how much of your wealth is already tied to it. Diversify: avoid concentrating more than a modest share of net worth in one company stock. Some plans allow cashless exercise by selling enough shares to cover cost and taxes.
Getting Advice
Stock option taxation is complex (state taxes, AMT credits, Section 83(b) elections for early-exercised options, and 409A valuations). Run scenarios before exercising, and consult a tax professional, especially for ISOs and private companies. This article is a simplified illustration and uses assumed rates.
Frequently Asked Questions
What is the spread on stock options?
The difference between the share's fair market value and the strike price.
How are NSOs taxed at exercise?
The spread is taxed as ordinary income.
How are ISOs different?
No regular tax at exercise, but possible AMT, and a qualifying sale is taxed as long-term capital gains.
How long do I have to exercise after leaving a company?
Often 90 days, but check your plan.
What is cashless exercise?
Selling some shares at exercise to cover the cost and taxes.