Let’s be honest: Stock options could make you rich. But employee stock option taxes can be complicated. And getting it wrong can have consequences — like the kind with a lot of zeros on the end. Understanding how options are taxed could help you avoid costly mistakes.
If you’re working out a plan for exercising stock options, consider finding a financial advisor with expertise in employee equity. That person could help you think through the timing, risks and benefits relevant to your unique financial situation.
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on SS Wealth Partners’ website. For informational purposes only. SS Wealth Partners does not provide tax or legal advice.
How employee stock options are taxed
How your employee stock options are taxed depends on the type of stock option you have.
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Nonqualified stock options (NSOs) are stock options that companies can issue to both employees and non-employees. NSOs are often taxed at a higher rate than incentive stock options. But their tax treatment is pretty straightforward: you pay ordinary income tax when you exercise the options and capital gains tax if you then later sell the shares for a profit.
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Incentive stock options (ISOs) are stock options that companies issue only to employees. They enjoy several tax benefits, but that tends to make the strategy more complicated. ISOs aren’t taxed when they’re granted, when they vest or when they’re exercised. Instead, you pay tax when you sell your shares. If you meet the holding-time requirements, you may pay capital gains tax rates instead of potentially less favorable ordinary income tax rates
National Archive Code of Federal Regulations. § 1.423-1. Accessed Oct 28, 2025..
Employee stock options taxes
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You may owe ordinary income taxes on the “bargain element,” which is the difference between the market price of the shares and the strike price. You’ll also be responsible for Medicare and Social Security taxes. Employers typically withhold and pay the taxes to the IRS on your behalf. |
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Any profit you make when selling your shares is subject to capital gains tax. Whether you pay short- or long-term capital gains tax rates depends on how long you own the shares. |
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Ask an advisor: Special considerations for stock option taxes
Understanding stock option taxes is one thing. Knowing how to navigate them strategically takes careful planning, and maybe some expert help.
“NSOs are inherently simple. There’s no choice apart from the choice of when to exercise,” says James Bashall, a financial advisor and chief operating officer with SS Wealth Partners. “With ISOs, there’s so much more strategy involved. That’s where the advisor becomes important.”
Here are two considerations when developing your stock option tax strategy.
1. Planning for AMT
When you exercise stock options, the discount you receive — also called the bargain element — is income in the eyes of the IRS. That extra income may make you subject to alternative minimum tax, or AMT.
AMT is a tax system that runs parallel to the standard tax system. It has different tax rates that are intended to ensure certain high-earning taxpayers pay at least a minimum level of income tax. Their income taxes are calculated under regular tax rules and under AMT rules, and they owe whichever tax bill is higher.
There are a number of strategies for navigating AMT. For example, Bashall says, if your goal is to avoid paying AMT, calculate how many shares you can exercise in the year without incurring AMT. That may mean you exercise your options in batches over the course of several years.
2. Holding or selling your shares
You may pay less tax if you hold your shares for at least a year after the exercise date and for at least two years after the grant date. But holding your shares isn’t always the best strategy, and avoiding taxes isn’t always the best goal, Bashall says.
Here are other factors to think through when weighing the pros and cons of holding your shares for a year or more.
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Managing cash flow: If exercising your options triggers a tax bill, you may need to come up with a hefty sum of cash. You’ll need to weigh the pros and cons of paying those taxes out of pocket or using the proceeds from selling some of your stock (if that option is available).
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Risk of lost value: If the company stock price drops, the value your options have when you exercise them could disappear. “Potentially exercising options and immediately selling [the shares] — you’re locking in the gain instead of running the risk of it turning into a loss over the next 12 months,” Bashall says.
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Concentrated exposure: If too much of your wealth is tied to the performance of a single company — your employer — you run the risk of losing it all if it tanks. Financial advisors generally encourage investors to diversify their portfolios and avoid having concentrated exposure in a single stock.