The short answer
A stock option lets you buy company stock at a set price (the exercise price). The tax depends on the type of option:
- Nonstatutory stock options (NSOs, also called nonqualified options): usually taxed as wages when you exercise, on the spread between the stock's value and the exercise price.
- Incentive stock options (ISOs): no regular income tax at exercise, but the spread can trigger the alternative minimum tax (AMT). If you meet the holding period, your whole gain on sale is capital gain.
ISO vs. NSO at a glance
| Stage | NSO (no readily determinable value) | ISO |
|---|---|---|
| Grant | No income | No income |
| Exercise — regular tax | Spread is compensation income, reported on Form W-2 (box 12, code V) | No income |
| Exercise — AMT | No separate adjustment (already taxed as wages) | Spread is generally an AMT adjustment on Form 6251, line 2i, unless you sell in the same year |
| Regular tax basis | Exercise price + income included | Exercise price (plus any ordinary income from a disqualifying disposition) |
| AMT basis | Same as regular basis | Exercise price + AMT adjustment |
| Sale | Capital gain or loss from your basis | Qualifying: all capital gain or loss. Disqualifying: part may be ordinary income |
| Form from your employer | Form W-2 | Form 3921 |
ISO holding period and disqualifying dispositions
You meet the ISO holding period if you don't sell until after the later of 2 years after the grant date or 1 year after the shares were transferred to you. You must also have been an employee of the company (or a related company) from the grant date until 3 months before exercise (1 year if you are disabled). In a disqualifying disposition with a gain, the gain is ordinary income up to the stock's value at exercise minus the exercise price, and the rest is capital gain. A loss is a capital loss with no ordinary income.
Examples (illustrative)
NSO: Ben has an NSO for 1,000 shares at $10. He exercises in April 2025 when the stock is worth $25. He has $15,000 of compensation income ($25 − $10, × 1,000) in his 2025 W-2 wages. His basis is $25,000 ($10,000 paid + $15,000 income). He sells in February 2026 for $30 a share ($30,000), less than a year after exercise, for a $5,000 short-term capital gain.
ISO, qualifying sale: Kim is granted an ISO on February 1, 2024, for 100 shares at $20. She exercises on March 3, 2025, when the stock is worth $50, and the shares are freely transferable. She sells on June 1, 2026, for $70 a share — after February 1, 2026 (2 years after grant) and March 3, 2026 (1 year after transfer).
| Regular tax | AMT (concept) | |
|---|---|---|
| 2025 (exercise year) | No income | Adjustment of $3,000 (($50 − $20) × 100) on Form 6251, line 2i |
| Basis in the shares | $2,000 | $5,000 ($2,000 + $3,000) |
| 2026 sale for $7,000 | Long-term capital gain of $5,000 | Gain figured from the $5,000 AMT basis is $2,000 |
Whether the $3,000 adjustment actually creates AMT for 2025 depends on Kim's whole return and the full Form 6251 calculation, which this guide does not perform.
ISO, disqualifying sale: if Kim instead sold all 100 shares on December 1, 2025, for $70, she would have $3,000 of ordinary income (the $50 value at exercise minus $20, × 100), reported as wages, and a $2,000 short-term capital gain from her $5,000 basis. Because she sold in the same year she exercised, no AMT adjustment is required for those shares.
Form 3921 and Form 1099-B
After you exercise an ISO, your employer should give you Form 3921 by January 31 of the next year. It shows the grant date (box 1), exercise date (box 2), exercise price per share (box 3), value per share on the exercise date (box 4), and number of shares (box 5). For options granted after 2013, the basis on Form 1099-B won't include any amount you reported as income, so you may need to adjust it on Form 8949 with code B. See cost basis and Form 1099-B.
Common mistakes
- Ignoring the AMT in the year you exercise ISOs and hold the shares.
- Keeping only one basis for ISO shares. You need both the regular tax basis and the AMT basis.
- Counting the holding period from the vesting date instead of the grant and exercise dates.
- Reporting NSO income twice — once in W-2 wages and again as capital gain because the basis was not adjusted.
- Assuming every option is an ISO. If the employment or transfer rules are not met, the option is an NSO.
Forms you will see
| Form | Use |
|---|---|
| Form W-2 | NSO exercise income (box 12, code V) and ISO disqualifying-disposition income |
| Form 3921 | ISO exercise information |
| Form 6251 | Alternative minimum tax, including the ISO adjustment (line 2i) |
| Form 1099-B, Form 8949 and Schedule D | Sale of the shares and any basis correction |
| Schedule 1 (Form 1040), line 8k | Option income not included on your W-2 |
The AMT examples above show concepts only. Whether you owe AMT depends on your full return and the Form 6251 calculation. Consider professional help before exercising a large number of ISOs. State tax treatment is not covered.