Incentive Stock Options (ISOs): What Tech Employees Need to Know

If you work in tech, there's a good chance stock options are part of your compensation. And if you've ever stared at your equity grant wondering what to actually do with it — you're not alone.

Incentive Stock Options (ISOs) are one of the most valuable perks a tech company can offer. But they're also one of the most misunderstood. Make the wrong move and you could end up with a surprise tax bill. Make the right move and you could save thousands.

Here's how they actually work.

The Three Stages of ISOs

Every ISO goes through three stages: you get them, you exercise them, and you sell them. The decisions you make at each stage have real financial consequences, so it's worth understanding each one.

Stage 1: Your Grant

When your company grants you ISOs, you'll receive a few key pieces of information:

• Grant Date — the date the options are officially yours

• Number of ISOs — how many options you've been granted

• Exercise Price (Strike Price) — what you'll pay to convert one ISO into one share of stock

• Vesting Schedule — the timeline or performance requirements you need to meet before you can act on them

• Expiration Date — the deadline to exercise before they disappear forever (typically 10 years from the grant date)

Example: You're granted 1,000 ISOs at a $10 exercise price, with a 1-year vesting schedule.

Stage 2: Exercising Your ISOs

Once your options vest, you have the choice to exercise them — meaning you pay the exercise price to convert your ISOs into actual shares of stock.

The key word there is choice. Whether it makes sense to exercise depends on how your exercise price compares to the current stock price.

Think of it like a coupon. If your coupon says "buy a sandwich for $7" but the sandwich only costs $5.50 at the counter, the coupon is useless. ISOs work the same way. If the current stock price is lower than your exercise price, your options are "out of the money" and not worth exercising. If the stock price is higher, they're "in the money" and have real value.

In our example, let's say the stock is now trading at $20 per share. You can pay $10,000 (1,000 shares × $10) to acquire something worth $20,000. That $10,000 difference is called the bargain element — and it matters a lot come tax time.

Stage 3: When to Sell (and What It Means for Your Taxes)

This is where most people get tripped up. There are two paths, and the difference between them can be thousands of dollars.

Path 1: Disqualifying Disposition (the more expensive route)

If you exercise and sell your shares quickly — without meeting certain holding requirements — the IRS treats your bargain element as ordinary income. That means it gets taxed at your regular income tax rate.

In our example, that $10,000 bargain element could cost you $3,200 in federal taxes if you're in the 32% bracket, on top of any state taxes.

Path 2: Qualifying Disposition (the tax-advantaged route)

Here's where ISOs get interesting. If you hold your shares long enough, you unlock long-term capital gains rates — which are significantly lower than ordinary income rates.

To qualify, you need to meet both of these rules:

• Hold the shares for more than 2 years from the grant date

• Hold the shares for more than 1 year from the exercise date

In our example, if the stock climbs to $25 per share by the time you sell, your total gain is $15,000. Under a qualifying disposition, you'd pay 15% on that gain instead of 32% — saving over $2,500 in federal taxes alone.

The AMT Trap (And How to Avoid It)

There's one more wrinkle you need to know about: the Alternative Minimum Tax, or AMT.

If you exercise ISOs and hold the shares through the end of the calendar year, the bargain element gets factored into your AMT calculation. That can mean an unexpected tax bill — and since you're holding the shares, you'd need to come up with that cash from somewhere else.

One strategy worth knowing: exercising early in the calendar year. This gives you time to meet the qualifying disposition holding requirements and potentially sell your shares before year-end if the AMT liability becomes a concern.

The silver lining is that any extra AMT you pay can often be recouped as a credit in future tax years.

The Bigger Picture

The math above assumes a best-case scenario where the stock keeps going up. In reality, you're also holding concentrated risk in a company that's your primary source of income — which adds another layer of complexity.

Before making any moves on your ISOs, it's worth asking yourself:

• Do I need the money now, or can I afford to wait?

• Am I comfortable having my job and a significant chunk of my wealth tied to the same company?

• What's my tax situation this year compared to future years?

ISOs can be a powerful wealth-building tool — but only if you approach them with a plan. If you're not sure where to start, working with a financial advisor who specializes in stock compensation can help you make decisions you'll feel confident about.

Disclaimer: This article is for educational and informational purposes only and does not constitute investment, tax, legal, or insurance advice. ISO and RSU taxation depends on your individual circumstances. Always consult with a qualified tax professional before making equity compensation decisions.