Last updated: September 29, 2025
What Makes ISOs Different
ISOs give you the right to buy company stock at a preset strike. Meet both holding rules, 1 year after exercise and 2 years after grant, and gains may qualify for long-term capital gains rates instead of ordinary income. For high earners, that spread is real money.
Watch the prior edition on 10b5-1 RSU planning (context for coordination): 10b5-1 Plans: From Legal Protection to Long-Term Diversification.
A lesser-known factor is the $100,000 ISO rule: only $100K (by grant-date FMV) can first become exercisable per year; the excess is treated like NSOs for tax purposes.
The AMT Trap (and How to Stay Out of It)
When you exercise ISOs, the “bargain element” (FMV − strike) is added to AMT income, even if you don’t sell. That’s why modeling matters.
Quick example: Exercise 5,000 options at $10 when the stock is $50 → $200,000 of AMT income. Without planning, that can create a painful “paper tax.”
- Exercise in smaller tranches across years.
- Target lower-income years (sabbatical, transition, partial retirement).
- Forecast AMT before you click “exercise,” and track potential AMT credit.
For a deeper dive on AMT basics, see: What Is the Alternative Minimum Tax (AMT)?
Timing > Price: When Exercises Make Sense
Price gets the headlines, but timing does the heavy lifting. If a big bonus/promotion is coming, consider delaying exercises. If a lower-income year is ahead, that can be the moment to pull the trigger and start the long-term clock.
Early Exercise & the 83(b) Election (when allowed)
Some plans allow early exercise of unvested ISOs. If permitted, and you file an 83(b) within 30 days, you elect to recognize income earlier (often at lower values), kick-starting your long-term capital gains clock. This can reduce future tax but adds risk because you’re paying tax before full vesting. Use it when valuation is modest, liquidity is planned, and you’re confident in the company and role.
Qualifying vs. Disqualifying Dispositions
Qualifying means you met both holding periods and keep ISO tax treatment. Disqualifying means you sold too soon:
- Up to the bargain element at exercise is taxed as ordinary income.
- Any additional gain is capital gain (short- or long-term based on post-exercise holding).
- Upside: a same-day sale can avoid AMT entirely, sometimes the smarter economic move.
Two Client Stories, Two Outcomes
Slow and Steady (Phased Plan)
$500K in vested ISOs and AMT anxiety. We set an annual AMT ceiling, staged four exercises across windows, and paired with charitable gifting and loss harvesting. Over 18 months, single-stock exposure fell to ~15% of net worth, a diversified portfolio was funded, and a lifestyle goal (vacation home) became real.
Quick Pivot (Cashless, Disqualifying)
Facing volatility, another leader used a cashless, same-day sale. Yes, it disqualified ISO treatment, but it avoided AMT, freed cash for a down payment, and built an emergency reserve. The “best” choice fit the household’s risk and cash-flow needs.
Practical ISO Moves You Can Use
- Map your ISO calendar: grant, vest, expiration, and separation rules.
- Set a concentration cap: many executives limit any single stock to 10–20% of net worth.
- Model exercises annually: right-size tranches to keep AMT manageable.
- Charitable gifting: consider appreciated shares after qualifying dispositions.
- Coordinate with RSU/10b5-1 plans: apply the same rules-based thinking even if mechanics differ.
7-Minute Video: The Full Equity Breakdown
This short overview covers ISOs, RSUs, ESPPs, NSOs, performance shares, and where 83(b) can fit.
Key Takeaways
- ISOs can convert effort into long-term, tax-efficient wealth.
- AMT is real but manageable with phased exercises and timing.
- Disqualifying sales can be optimal for liquidity or risk control.
- Diversification, not concentration, should be the end state.
FAQs
How are ISOs taxed differently from NSOs?
ISOs may qualify for long-term capital gains if you meet the 1-year/2-year holding rules. NSOs typically generate ordinary income at exercise. The gap can be material for high earners.
What is the $100,000 ISO rule?
Only $100K (by grant-date FMV) can first become exercisable per year as ISOs; the excess is treated like NSOs for tax purposes. It changes taxation, not the underlying value.
How do I avoid or reduce AMT on ISOs?
Exercise in tranches, target lower-income years, and run AMT forecasts before exercising. Track potential AMT credit for future years.
Is a disqualifying disposition always bad?
No. A planned disqualifying sale may avoid AMT, improve liquidity, and reduce risk. The “right” choice depends on goals and cash-flow needs.
What’s the role of early exercise and 83(b)?
When allowed, early exercise plus a timely 83(b) may start the long-term clock earlier at lower values, but you pay tax before full vesting. Use selectively and with planning.
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