ISO vs NSO Stock Options: What Happens When You Cross the $100K Rule?

If you’ve been granted Incentive Stock Options (ISOs) by your company, you’re probably hoping to cash in someday without paying hefty taxes. But once your exercised ISOs exceed $100,000 in fair market value (FMV) in a single calendar year, things get complicated and you may end up paying taxes on stock you haven’t even sold.

Let’s break this down in plain English.

What’s the Difference Between ISOs and NSOs?

Before we dive into the $100K rule, here is a quick refresher.

ISOs (Incentive Stock Options)

• Preferred tax treatment

• No ordinary income tax at exercise

• Unrealized gain factors into Alternative Minimum Tax (AMT)

NSOs (Non Qualified Stock Options)

• Ordinary income tax applies when exercised

• No AMT impact

• Higher up front tax cost

The $100K ISO Limit Rule

The IRS limits the amount of ISOs that can receive favorable ISO treatment each year to $100,000 in FMV, based on the grant date strike price, not the FMV at exercise.

If you exercise ISOs that exceed $100,000 in value in one calendar year:

• The first $100,000 qualifies for ISO treatment

• Anything above that is treated as NSOs

This means you may owe ordinary income tax on part of your exercise, even though you have not sold the shares.

Can You Owe Taxes Without Selling Your Stock?

Yes, and this is where AMT (Alternative Minimum Tax) comes in.

Under regular tax rules, ISOs are not taxed at exercise
For AMT purposes, however, the spread (FMV - strike price) is treated as income

If that spread is large, AMT can apply and create a significant tax bill on paper gains alone

Example 1: Staying Under the $100K Limit

You have:

• 8,000 ISO shares

• Strike price: $12.50

• FMV at exercise: $45

Grant date FMV value:
8,000 shares × $12.50 = $100,000

All 8,000 shares qualify for ISO treatment

AMT calculation:
($45 − $12.50) × 8,000 shares = $260,000 added to AMT income calculation

Whether AMT is actually owed depends on the rest of your tax return. This large unrealized gain is now part of the AMT calculation, which is why personalized planning is critical

Example 2: Crossing the $100K ISO Limit

You have:

• 8,000 ISO shares

• Strike price: $20

• FMV at exercise: $45

ISO and NSO split

First 5,000 shares:
5,000 × $20 = $100,000
These shares qualify for ISO treatment

Remaining 3,000 shares:
Exceed the $100,000 cap and are treated as NSOs

Tax impact

ISO portion (AMT):
($45 − $20) × 5,000 shares = $125,000 of unrealized gain added to AMT income calculation

NSO portion (ordinary income):
($45 − $20) × 3,000 shares = $75,000 added to taxable income and taxed as ordinary income

Assume:

• Your regular tax liability before exercising was $50,000

• The additional $75,000 of income is taxed at 32 percent

That adds approximately $24,000 of tax, bringing your regular tax liability to $74,000

Your AMT calculation still includes the $125,000 ISO spread. However, because your regular tax is now higher, the additional AMT owed is lower

Why does AMT go down?

AMT is a minimum tax, not an extra tax. The more tax you pay under the regular system, the less AMT is needed to bring you up to the minimum

But What About AMT Credit?

If you do pay AMT, the tax does roll forward as an AMT credit. However, this credit is not automatically refundable and should not be viewed as guaranteed savings.

The IRS only allows you to apply the AMT credit in future years when AMT is triggered again. If you do not hit AMT in later years, the credit may sit unused.

In practice, we often see clients pay significant AMT and never fully recover it. Income stays high, equity compensation continues, or AMT applies again and again, preventing full utilization of the credit.

This is why AMT is often a phantom tax and must be factored into your exercise decision upfront, not treated as something that will simply work itself out later.

This Sounds Confusing Because It Is

ISO and NSO taxation, especially when AMT is involved, is one of the most complex areas of tax planning

We do not rely on back-of-the-napkin calculations when AMT is in play. Instead, we prepare proforma tax returns with our clients and run their full tax return through multiple scenarios

Why does this matter
Because once you cross the $100,000 ISO threshold or trigger AMT, the numbers can change quickly and swing dramatically. A small change in timing or income can result in tens of thousands of dollars of additional tax

This is not guesswork. It is modeling, planning, and strategy

Why This Happens

• The IRS allows favorable ISO treatment on up to $100,000 per year based on grant date FMV

• Anything above that is taxed as an NSO and creates ordinary income

• Even if you do not sell the shares, AMT may apply to the paper gain

• The higher the stock price, the higher the potential AMT exposure

Key Takeaways

• Only $100,000 worth of ISOs by grant date FMV can qualify for ISO treatment each year

• Anything above that amount is taxed as an NSO

• ISOs can trigger AMT even if you never sell the stock

• You may get an AMT credit, but full recovery is not guaranteed

• Small changes can have large tax consequences

• Planning before you exercise is essential

Need Help?

If you are sitting on ISOs or NSOs and are unsure how or when to exercise, book an Equity Compensation Consult and understand your personal tax situation clearly before you decide to exercise or sell.

A thoughtful strategy today can help you avoid a surprise tax bill and keep more of your hard earned equity tomorrow