Exercising stock options: how the taxes work, with an example

Written by The Dynasty Team | Sep 24, 2026, 6:02:54 AM

When you exercise options, and when you sell the shares, can change how much you keep. Here's how the main choices work, with a simple example.

Two ways to exercise once your company is public

	Cash exercise (exercise and hold)	Cashless exercise (same-day sale)
What happens	You pay the exercise price out of pocket and keep the shares	Shares are exercised and sold at once. The exercise price and taxes come out of the proceeds
Where you do it	Through your equity plan administrator	Through your plan's broker
When it's available	Before or after an IPO, depending on your plan	Only when you're allowed to sell, after any lockup and during an open trading window
ISOs	No withholding at exercise, but AMT may apply	The spread is taxed as ordinary income (a disqualifying disposition)
NSOs	Tax withheld at exercise	Tax withheld at exercise

Qualifying and disqualifying dispositions

For ISOs, the tax treatment depends on how long you hold the shares. Sell more than two years after the grant date and more than one year after you exercise, and it's a qualifying disposition: the gain is taxed at long-term capital gains rates. Sell earlier, including in a same-day sale, and it's a disqualifying disposition: the spread is taxed as ordinary income. NSOs can't qualify, because the spread at exercise is always ordinary income.

An example

Say you hold 1,000 options with a $2.00 strike price and sell the shares at $20.00.

Same-day sale (disqualifying)

Step	Amount
Gross sale proceeds (1,000 × $20.00)	$20,000
Exercise cost (1,000 × $2.00)	−$2,000
Ordinary income	$18,000
Federal income tax at 37%	−$6,660
State income tax at 5%	−$900
Net after taxes and costs	$10,440

Held for the qualifying period (ISOs only)

Step	Amount
Gross sale proceeds (1,000 × $20.00)	$20,000
Exercise cost (1,000 × $2.00)	−$2,000
Long-term capital gain	$18,000
Federal long-term capital gains tax at 20%	−$3,600
Net investment income tax at 3.8%	−$684
State income tax at 5%	−$900
Net after taxes and costs	$12,816

Illustrative only. The example assumes top federal rates, a hypothetical 5% state rate, and the same $20.00 sale price in both cases. In reality the share price can rise or fall while you hold, holding means paying the exercise cost up front, and AMT may apply in the year you exercise. Your actual numbers depend on your full tax situation.

What to plan for

Timing exercises and sales across tax years to manage your tax bracket
Estimated tax payments when withholding falls short
Whether AMT applies if you exercise ISOs and hold the shares
Whether the simplicity of a same-day sale is worth the higher tax for part of your position

Because the right answer depends on your income, your other holdings, and your plans, this is a decision worth modeling with a tax professional before you act.

View full post