ISO vs NSO Stock Options: Taxes, AMT and the 90-Day Window
Incentive and nonqualified stock options look alike on a grant letter but are taxed very differently. How each works at exercise and sale, and why leaving a job changes the math.
Incentive stock options (ISOs) and nonqualified stock options (NSOs) differ mainly in tax timing. Exercising an NSO creates ordinary wage income on the spread right away. Exercising an ISO creates no regular income tax, but the spread counts for the alternative minimum tax (AMT), and the best treatment requires holding the shares. Your grant agreement states which type you have.
The rules below come from IRS Topic 427 and Publication 525, checked as of November 2026. They explain how the tax works; whether and when to exercise depends on your own finances, and a tax professional can model it for you.
What is the difference between an ISO and an NSO?
An ISO is a “statutory” option that meets the requirements of Internal Revenue Code section 422; an NSO, also called a nonstatutory or nonqualified option, is any option that does not. ISOs can be granted only to employees. NSOs can go to employees, contractors, advisors and directors.
| ISO | NSO | |
|---|---|---|
| At grant | No tax | No tax for typical options with no readily determinable value |
| At exercise, regular tax | None | Spread (market value minus exercise price) is ordinary income, reported on Form W-2 for employees |
| At exercise, AMT | Spread is an AMT adjustment (Form 6251) unless you sell in the same year | Not an AMT item |
| Payroll taxes at exercise | None | Social Security and Medicare apply to the spread for employees |
| At sale, holding period met | Whole gain over exercise price is long-term capital gain | Gain after exercise is capital gain, long-term if held over a year |
| At sale, holding period missed | “Disqualifying disposition”: part of the gain becomes ordinary income | Not applicable |
| Tax form from employer | Form 3921 after exercise | Income included on Form W-2 |
| Who can receive | Employees only | Employees and non-employees |
What holding period do ISOs require?
To get capital gain treatment on the whole gain, you must not sell ISO shares until the later of two dates: two years after the option was granted and one year after you exercised it. Publication 525 calls meeting this the “holding period requirement.”
If you sell earlier, it is a disqualifying disposition. Your gain is ordinary income up to the spread at exercise, and any gain above that is capital gain. If you sell at a loss, it is a capital loss with no ordinary income. Your employer or former employer should report the ordinary part as wages on Form W-2.
Why ISOs can trigger the alternative minimum tax
For AMT purposes, the IRS treats an ISO exercise as if no special rule applied: the spread is added to alternative minimum taxable income in the year the shares vest or become transferable. If that pushes your tentative minimum tax above your regular tax, you owe AMT for the year, even though you sold nothing. You also get a separate AMT basis in the shares, which is why records from Form 3921 matter later. No AMT adjustment is required if you sell the shares in the same year you exercise.
What is the $100,000 ISO limit?
Only $100,000 worth of ISOs can first become exercisable in any calendar year, measured by the stock’s value on the grant date. Options above that amount are treated as NSOs under section 422(d), counted in the order granted. Large grants with fast vesting are often split, part ISO and part NSO, for this reason. Your equity portal usually shows the split.
What happens to ISOs when you leave or are laid off?
To keep ISO tax treatment, you must exercise within three months after your employment ends (one year if you leave because of disability). This comes from the statute’s employment requirement: you must be an employee from grant until three months before exercise. After that, an unexercised ISO can still be exercised only if the plan allows it, and it is then taxed as an NSO.
Separately, many plans set a deadline to exercise at all, often matching the 90-day ISO window, after which unexercised options expire. Some companies offer longer post-termination windows, which turns the options into NSOs after the first three months. The deadline that applies to you is in your grant agreement and the plan document.
- After a layoff: the three-month clock and the plan’s expiration clock both start on your termination date, at the same time you may be dealing with severance and benefits. See our guide to severance pay rules.
- After an acquisition: options may be cashed out, converted into buyer options or canceled under the merger agreement. A conversion done properly usually keeps ISO status. See stock options in an acquisition.
- After an IPO: lockups can stop you from selling shares for months after exercising; see IPO lockup periods.
Which questions should you ask before exercising?
- Is each grant an ISO, an NSO or split, and how much of each?
- What is the current fair market value per share (the 409A value at a private company)?
- When does each option expire, including after you leave?
- Does the plan allow early exercise of unvested options, and does that require an 83(b) election?
- Can the shares be sold, and when, under company rules or a lockup?
HR or the plan administrator can answer the plan questions. A tax professional can estimate the regular tax, AMT and payroll tax for a specific exercise.
Bottom line
Form 3921 arrives by January 31 of the year after an ISO exercise and lists the grant date, exercise date, exercise price and fair market value on the exercise date. Those four numbers are what you or your preparer need to compute both the AMT adjustment now and the holding period test later, so keep every copy.
FAQ
Are ISOs always better than NSOs?
Not always. ISOs can produce lower tax if you exercise and hold, but they carry AMT risk and holding-period risk, while NSOs are taxed at exercise with withholding, which is simpler to plan for.
Is selling ISO shares right after exercise a mistake?
It is a disqualifying disposition, so the spread is taxed as ordinary income, similar to an NSO. It also avoids the AMT adjustment for that exercise because the sale happens in the same year.
Do NSOs have a holding period?
No special one. Gain after exercise is long-term capital gain if you hold the shares for more than one year from the day after exercise, and short-term otherwise.
