How are stock options taxed - "regular income" vs "short term capital gains"? Tax implications explained

The tax treatment of ISOs can be a bit complicated, but let me break it down for you in simpler terms. When you exercise ISOs, you're not immediately taxed on the difference between the strike price and fair market value (this is different from non-qualified options). However, this difference ($53 in your example) can trigger Alternative Minimum Tax (AMT) in the year you exercise. If you exercise and sell immediately (same day), this is called a disqualifying disposition. The entire spread ($53 in your case) would be treated as ordinary income, not capital gains. So unfortunately, this couldn't be used to offset your husband's carried-over capital losses. If you exercise now and hold the shares for at least 1 year from exercise AND 2 years from the grant date before selling, then any gain would qualify for long-term capital gains treatment. In this scenario, you'd potentially pay AMT in the year of exercise, but the eventual sale would be eligible for the lower long-term capital gains rate.

I went through a similar situation last year and found https://taxr.ai extremely helpful for sorting through my stock option taxation issues. My company had also just gone public, and I was confused about how to handle my ISOs vs NSOs and the AMT implications. The service analyzed my grant documents and company stock plan, then gave me personalized tax scenarios based on different exercise strategies. It showed me exactly what would happen if I exercised and held vs. exercised and sold immediately, including the potential AMT hit (which was way bigger than I expected!). They even helped me understand which specific options to exercise first based on grant dates and valuations to minimize my overall tax burden. Definitely worth checking out if you're trying to make sense of all the rules around ISOs.

Just wanted to update on my experience with taxr.ai after the recommendation above. I was initially skeptical but decided to try it since our situation with ISOs was getting complicated with my husband's capital losses. I'm really glad I did! They identified that I could exercise a specific portion of my options this year (about 30% of my grants) without triggering AMT, which I had no idea was possible. This let us start the holding period clock for long-term capital gains while minimizing immediate tax impact. They also explained a strategy where I could exercise another portion in January 2025 and immediately sell just enough to cover the taxes. This approach lets us use some of my husband's carried-over losses while still keeping some upside potential. Definitely recommend for anyone dealing with stock options - would have paid my accountant way more for less specific advice.

If you're struggling to get tax advice on these ISO questions, you might want to try https://claimyr.com to get through to an actual IRS agent. I had been trying for WEEKS to get clarity on a similar ISO situation (particularly around AMT calculations) and kept getting the "call volume too high" message. Used this service and got connected to an IRS representative within about 20 minutes instead of the 3+ hours I had been waiting before. The agent was able to confirm exactly how the AMT preference item should be calculated and when the disqualifying disposition rules apply. You can see how it works here: https://youtu.be/_kiP6q8DX5c Obviously they can't give you tax planning advice, but if you have specific questions about how certain option transactions get reported, they can provide official guidance which is sometimes better than conflicting online advice.

I need to eat my words. After posting my skeptical comment above, I decided to try Claimyr since I was also stuck on how to handle reporting some exercised options from last year that I'm still holding. I had tried calling the IRS 4 times over the past month and always hung up after being on hold for over an hour. With this service, I got a call back in 34 minutes with an actual IRS tax specialist on the line. The agent explained exactly how to report my ISO exercise on Form 6251 for AMT purposes, and confirmed that since I hadn't sold any shares yet, I don't need to report anything on Schedule D this year. They also explained what records I need to keep for when I do eventually sell. Totally worth it just for the time saved. I was losing entire afternoons to being stuck on hold.

One thing I haven't seen mentioned here is the 83(b) election for ISOs that haven't vested yet. If your company just IPO'd and some of your options aren't vested, you might want to look into this. It starts the capital gains holding period early. But be super careful - there's a strict 30-day window to file after exercise, and you can't undo it if the stock tanks. I did this with a previous company and it worked great, but another friend did it and the company went bankrupt, so he paid taxes on value he never got.

Don't forget to run the numbers on selling enough to cover the taxes! My wife got hit with a MASSIVE tax bill when she exercised her options after IPO but didn't sell enough to cover taxes. The AMT calculation was insane.

Remember that you also need to think about state taxes! Federal rules are one thing, but states often have different treatment. I'm in California and they don't have an AMT system that matches federal exactly, so my calculations were all different. Make sure you're considering both.

Great question! As someone who's been through a similar situation, I can confirm what others have said about the complexity of ISO taxation. One thing I'd add is to consider the timing of your exercise in relation to your company's lock-up period ending (if applicable). Many people exercise right after IPO without realizing they can't sell during the lock-up, which can create cash flow issues if AMT kicks in. Also, since you mentioned your husband has significant short-term capital losses to carry forward, you might want to explore a mixed strategy: exercise some options now and hold (to start the long-term capital gains clock), and plan to exercise additional tranches in future years when you can immediately sell to utilize those losses. One more tip - if you're planning to exercise and hold, make sure you have enough cash set aside for the potential AMT hit. I've seen too many people get caught off guard by the tax bill on "paper gains" they haven't actually realized yet. The AMT can be substantial even when you haven't sold anything. Good luck with your decision!