How ISOs are taxed
Incentive stock options let you buy company shares at a fixed strike price. For regular income tax, nothing happens when they are granted or when you exercise them. The tax you owe depends on when you sell.
- Qualifying sale: you sell at least 2 years after the grant date and at least 1 year after exercise. The whole gain over the strike price is a long-term capital gain.
- Disqualifying sale: you sell sooner. The spread at exercise is taxed as ordinary income, and any further gain is a capital gain.
Your company reports each exercise on Form 3921, which arrives by January 31.
Where AMT comes in
The Alternative Minimum Tax is a second way of calculating tax, and you pay whichever is higher. When you exercise ISOs and hold the shares past year-end, the spread (market value minus strike price, times shares) counts as income for AMT, even though you received no cash.
| Example exercise | Amount |
|---|---|
| 2,000 shares, strike price $5 | $10,000 to exercise |
| Market value at exercise: $45 a share | $90,000 |
| Spread added for AMT | $80,000 |
Whether that spread creates AMT depends on your other income and deductions. Each person has some room below the AMT line, and the AMT exemption shrinks as income rises. Rule changes that took effect in 2026 make it phase out faster for higher earners, so modeling before you exercise matters more than ever.
Ways to plan around it
- Exercise up to the line. Calculate how many shares you can exercise each year before AMT applies, and spread exercises across years.
- Exercise early in the year. The 1-year holding clock starts sooner, and if the price falls before December 31 you can still sell in the same year to avoid AMT on the spread.
- Exercise and sell in the same year. A disqualifying sale removes the AMT adjustment, at the cost of ordinary income tax on the spread.
- Consider early exercise with an 83(b) election when your plan allows it and the spread is small, so there is little or nothing to add for AMT.
The AMT credit
AMT paid because of ISO exercises is not always lost. It usually creates a minimum tax credit that you can use in later years when your regular tax is higher than AMT, tracked on Form 8801. Many people never claim it.
Two rules people miss
- The 90-day rule: after you leave the company, ISOs generally must be exercised within 3 months to keep ISO treatment. After that they are treated as non-qualified options.
- The $100,000 limit: ISOs that first become exercisable in one year above $100,000 of value, measured at grant, are treated as non-qualified options.