How do taxes work on stock options? Are they taxed as regular income or short term capital gains?

I'm trying to figure out how taxes work for stock options since my wife just got a bunch of ISOs when her company went public. I'm pretty familiar with RSUs from my own job, but options are new territory for us. Her options are definitely in the money right now, and I'm trying to make a smart tax decision. I have a lot of short term capital gains losses from a few years back that I'd love to offset if possible. Let me see if I understand this correctly: If her options have a strike price of $6.50 and the current stock price is $65, that's a $58.50 gain per share. If we exercise and sell immediately, is that $58.50 considered short term capital gains? Can I use that to offset my carried-over losses? Or is it just considered regular income? And if we exercise now but hold until July 2025 before selling, would the entire $58.50 gain be considered long term capital gains (assuming the stock price stays the same)? Thanks for any help understanding how these ISO tax implications work!

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18 comments

Gabrielle Dubois

•8M

The taxation of ISOs (Incentive Stock Options) is a bit more complex than RSUs. Here's what you need to know: When you exercise ISOs, the difference between the market price and the exercise price (the "spread") isn't taxed as regular income, BUT it can trigger Alternative Minimum Tax (AMT). This is different from non-qualified options which are taxed as ordinary income at exercise. If you exercise and sell immediately (a "disqualifying disposition"), the entire gain is treated as ordinary income, not capital gains. So in your example, the $58.50 wouldn't offset your capital loss carryover. However, if you exercise and hold the shares for at least 1 year from exercise AND 2 years from the grant date (a "qualifying disposition"), then when you sell, the difference between the sale price and exercise price is long-term capital gains. The timing matters a lot here - especially with the AMT considerations.

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Gabrielle Dubois

•8M

ISOs have special tax treatment that makes them different from just buying and selling stock. When you exercise and immediately sell ISOs (or sell within 1 year of exercise), the IRS considers it a "disqualifying disposition" and the spread is treated as ordinary income on your W-2, not as capital gains. AMT (Alternative Minimum Tax) is a parallel tax system designed to ensure people with significant deductions and tax preferences pay at least a minimum amount of tax. When you exercise ISOs but don't sell right away, the paper gain (the spread) isn't subject to regular income tax but may be subject to AMT. It's essentially a tax on "paper profits" even though you haven't sold the shares yet.

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Ingrid Larsson

•8M

I went through something similar last year with my partner's ISOs. I was so confused about how to handle the taxes until I found https://taxr.ai which literally saved me thousands! They have this awesome tool that analyzes your stock options and shows you different exercise scenarios with the tax implications. What was super helpful was that they showed me exactly how much AMT I'd have to pay if we exercised without selling right away. They also helped us figure out the optimal amount to exercise each year to minimize our overall tax burden. You can upload your grant documents and they break everything down for you in plain English.

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Ingrid Larsson

•8M

Yes, it works for both ISOs and NSOs. The platform actually explains the differences between them and how each is taxed in different scenarios. It even helps with RSUs too if you want to compare all your equity compensation in one place. The accuracy is what impressed me most. It catches those edge cases that other calculators miss. For example, it showed how exercising too many ISOs would push us into AMT territory, but exercising just under a certain threshold would avoid it completely. The AMT calculations were spot-on when we compared with our actual tax return.

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Zainab Mahmoud

•8M

I was super skeptical about taxr.ai at first because I've been burned by "tax calculators" before, but I decided to give it a try after seeing it recommended. HOLY CRAP it was a game changer for handling my stock options! I uploaded my grant documents and it showed me that exercising all at once would have triggered over $18K in AMT, but if I split it across December 2024 and January 2025, I could reduce that by more than half! It also clearly showed which of my options qualified for LTCG treatment and which didn't. Their explanations about disqualifying dispositions vs qualifying dispositions made everything click for me in a way my accountant never explained. Definitely worth checking out if you're trying to optimize your wife's ISO strategy!

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Ava Williams

•8M

If you're having trouble getting clear answers about your ISO tax situation, I'd recommend trying to speak directly with an IRS agent. I know that sounds impossible, but I used a service called https://claimyr.com that got me through to an IRS specialist in under 45 minutes when I had complex questions about my equity compensation. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c I was skeptical at first, but after waiting on hold for 3+ hours myself with no luck, I tried Claimyr. They called the IRS, navigated the phone tree, waited on hold, and then called me when an agent was actually on the line. The agent was able to confirm exactly how my ISO exercise would be treated for tax purposes and explained the AMT implications.

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Ava Williams

•8M

Yes, that's exactly how it works! They have an automated system that calls the IRS, navigates through all the annoying phone menu options, and then waits on hold so you don't have to. When an actual IRS agent picks up, their system calls you and connects you directly to the agent. It's simple but brilliant. I totally get the skepticism. I felt the same way before trying it. The difference is they have systems set up to keep trying and stay on hold indefinitely, whereas when we call as individuals, we might get disconnected or have to hang up eventually. It's basically like having a dedicated assistant whose only job is to wait on hold with the IRS for you.

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Lena Müller

•8M

I have to eat my words about Claimyr. After posting my skeptical comment, I decided to try it anyway because I was desperate to get an answer about my ISO exercise that triggered AMT. I'm honestly shocked - it actually worked! They called me back in about 53 minutes with an IRS agent on the line. The agent explained exactly how my ISO exercise would be reported on my tax return and confirmed that yes, when you exercise and sell immediately, it's ordinary income (W-2), not capital gains. She also explained that if I exercise and hold, I need to file Form 6251 to calculate my potential AMT liability. This was info I couldn't find clearly explained anywhere online. Worth every penny not to waste an entire afternoon on hold!

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TechNinja

•8M

Form 3921 won't calculate the AMT adjustment for you - it just provides the information you need to do that calculation yourself (or that your tax software will use). The form shows the exercise price, fair market value at exercise, and date information you need. California is indeed one of those states that taxes all income at the same rates regardless of whether it's capital gains or ordinary income. But given your federal carryover losses, it's worth talking to a tax professional about timing. Even though the ISO exercise+immediate sale would be ordinary income, there might be other strategies to utilize those capital loss carryovers in the same tax year.

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