7 Things to Settle Before You Exercise Your Startup Stock Options
Sam's List Editorial | 2026-08-03
7 Things to Settle Before You Exercise Your Startup Stock Options The expensive mistakes people make when they exercise startup stock options almost never involve the strike price. They involve a tax bill nobody warned them about, arriving in April for shares they cannot sell. Exercising is a purchase. You are writing a real check for illiquid stock in a private company, and in some cases triggering tax on paper gains in the same year. Here are the seven things to settle before you do it, in the order they actually matter. 1. Know Whether You Hold ISOs or NSOs This is the first question and most people cannot answer it from memory. Incentive stock options and non-qualified stock options are taxed on completely different timelines, and your grant agreement says which one you have. With an NSO, the spread between your strike price and the current fair market value is ordinary income at exercise. It shows up on your W-2 and your employer withholds on it. With an incentive stock option under IRC Section 422, there is generally no regular income tax at exercise, which sounds better until you read item three. Pull the grant agreement and the option plan document before you do anything else. If the paperwork is ambiguous, ask your equity administrator in writing. 2. Calculate the Full Cash Cost, Not Just the Strike The cost of exercising is two numbers, and people budget for one. The first is the exercise cost itself: strike price times the number of shares. The second is the tax the exercise triggers in the same calendar year. For NSOs that is withholding on the spread, often at supplemental rates that leave you owing more at filing. For ISOs it can be alternative minimum tax. Neither number comes with cash to pay it. Private stock does not sell itself, and a paper gain does not fund a tax bill. Write both numbers down before you decide how many shares to exercise. 3. Model Your AMT Exposure Before You Exercise ISOs The ISO bargain element, meaning fair market value at exercise minus your strike price, is an adjustment for alternative minimum tax purposes even though it is not regular taxable income. Exercise enough ISOs in a year with enough spread and you can owe AMT on money you never received. This is the specific scenario that has cost startup employees more than any other: exercise in a year when the 409A valuation is high, the company stays private, the valuation later falls, and the tax was already due. The AMT paid may generate a credit usable in later years, but that credit does not help your April cash flow, and a later decline in value does not...
