What Gen Z startup workers should know about ISO tax treatment

So, your startup just handed you an equity package, and now you're sitting on something called incentive stock options—aka ISOs. You smile, nod, and promise yourself you’ll “figure it out later.” Well, later is now, and this is your no-BS guide to how ISOs work, how they’re taxed, and how to avoid blowing your shot at a financial win.

First thing: ISOs are not free shares. You don’t own anything yet. You have the right to buy company stock at a set price, called the strike price. The magic only happens when your company grows and the stock price goes up—but there’s tax logic you’ve got to follow or you’ll be paying a steep price.

ISOs are like call options your company gives you as part of your compensation. You can buy shares at the strike price, usually set on the date you got them (the grant date). If your company’s value rises, that price stays locked—and you get the upside.

But they don’t just show up in your account. You need to wait until they vest, decide when to exercise, and figure out when—or if—you want to sell. These decisions impact your taxes more than your paycheck ever will. And don’t let the “stock option” name fool you. You don’t own equity until you exercise. You’re just holding a key to a door that may or may not open.

There are two tax systems you need to think about with ISOs: the regular income tax system and a weird shadow version called AMT (Alternative Minimum Tax). And this is where most employees screw it up—not because they’re careless, but because no one explains the rules clearly.

Tax Scenario A: You Play It Safe (But Pay More)

Let’s say you exercise and immediately sell. Boom—you're taxed right away. The gain (stock price minus strike price) is counted as ordinary income, taxed at your marginal rate.

It's simple, but you lose the ISO advantage, which is the ability to turn your profit into a long-term capital gain—taxed at a lower rate (like 15%) versus ordinary income (which could be 24–37%). Still, sometimes this makes sense—especially if your company isn’t public yet and holding onto private shares could be a risky HODL situation.

Tax Scenario B: You Wait (and Get Rewarded…Maybe)

Now let’s say you exercise but don’t sell. You hold for at least one year after exercising and two years from the grant date. If the stock has gone up, you only pay long-term capital gains tax on the profit when you eventually sell. That’s the golden ISO move. But there’s a catch—the AMT.

Here’s where things get wild. If you exercise ISOs but don’t sell in the same year, the IRS looks at the difference between your strike price and the stock’s fair market value (FMV) on the day you exercised—and says, “That counts as income for AMT purposes.” Even though you haven’t sold the shares or received any cash. Yeah.

So now you could owe thousands in taxes on phantom income. People have gone broke trying to pay taxes on stock they couldn’t sell or that later dropped in value. And if you’re thinking, “That’s just for rich tech bros,” think again. AMT can hit anyone who exercises a large ISO grant, especially at a fast-growing company.

There’s a rule that says you only get ISO tax treatment on $100,000 worth of options that become exercisable in a single calendar year. Anything above that? It automatically becomes non-qualified stock options (NSOs)—which get taxed like regular income.

It’s one of those “fine print” rules that can mess with your strategy, especially if you were planning to do a big exercise before an IPO. So don’t just look at your total number of options—figure out how much is within the ISO limit each year. If you don’t, you could be paying income tax instead of capital gains and not even know why.

The truth is, exercising early—like as soon as your options vest—can be smart if the company is still private and the FMV is close to your strike price. That’s because:

• There’s minimal spread, so less AMT risk
• You start your holding period early, so you're eligible for long-term capital gains sooner

But there’s a big “if.” You need to be okay with:

• Writing a check (and paying taxes) without a liquidity event in sight
• Holding shares that may never be worth anything

Some startups never IPO. Some get acquired and your shares get diluted or repriced. So don’t exercise with rent money.

Also, watch out for expiration. ISOs typically expire 10 years after the grant date—or 3 months after you leave the company. That short window post-exit trips up a lot of people. They leave, miss the exercise deadline, and poof—those juicy ISOs vanish.

If your company is public or gets acquired, you’ll eventually have the chance to sell your shares. But when should you? If you’ve held the shares long enough to meet the ISO timing rules (2 years from grant + 1 year from exercise), you get capital gains tax. That’s good. If not, and you sell earlier, the sale becomes a disqualifying disposition and the profit (the spread between strike and FMV at exercise) gets taxed as ordinary income.

Sometimes, it makes sense to sell early anyway—especially if:

• You need liquidity
• You want to avoid AMT
• You don’t believe the stock will go much higher

In other words: don’t get obsessed with tax efficiency at the cost of financial common sense.

ISOs and NSOs look similar but play by different rules. NSOs are more common in late-stage or public companies. They:

• Can be granted to anyone (not just employees)
• Are taxed as income when exercised
• Don’t have special tax perks like ISOs

So if your offer includes both types, read the fine print. And don’t assume every option you have is an ISO just because you work at a startup.

Let’s be real. Most ISO fails aren’t because people are lazy—they’re because the tax logic is confusing and HR doesn’t explain it. Here are a few classic traps:

Exercising too late. You wait until the FMV is way above your strike price and get hit with a big AMT bill—even if the company is still private and you can’t sell.

Missing the holding periods. You sell early and lose your shot at capital gains. Ouch.

Forgetting about expiration. You leave the company, forget the 90-day clock, and lose thousands of options.

Over-exercising. You blow past the $100K ISO limit and end up with NSO tax treatment you weren’t expecting.

Ignoring AMT. You owe tax on stock you can’t sell—and have no idea how to pay it.

Incentive stock options can be a wealth builder—but only if you treat them with the respect they deserve. They’re not guaranteed money. They’re a bet on your company and your timing.

Here’s the smart-person playbook:

• Know your vesting schedule inside out.
• Model the tax scenarios before you exercise anything.
• Don’t exercise more than you can afford to lose.
• Talk to a tax pro, especially before a major life change (like quitting, exercising big, or IPO timing).
• Sell strategically—don’t hold forever just because someone on Reddit said so.

At the end of the day, ISOs are like choosing your own financial adventure. Play it right, and you could turn paper promises into real gains. Play it blind, and you’ll wonder where all your money went—without ever seeing it in your account.