Examine Your ISO Strategy: Creating Value & Saving Taxes in 2026

Incentive Stock Options (ISOs), also called qualified stock options, are used by employers to attract, reward, and retain employees. Unlike other stock options, ISOs can receive more favorable tax treatment if certain requirements are met. Those requirements, however, increase the risks and complications. Knowing how and when to exercise will improve your chances of optimizing the ISO’s value and tax benefits.

What is a stock option?

A stock option grant gives you the right to buy shares of stock at a specific price during a particular window. The most common stock options are restricted stock units (RSUs), Non-qualified stock options (NSOs), and ISOs. 

There are 5 items you must understand when it comes to ISOs:

1. GRANT DATE: The date the stock options are given to you. 
2. VESTING SCHEDULE:  This is when you can exercise your options, and how many shares can be exercised. 
3. EXERCISE PRICE: Also called the strike price or grant price, this is the price per share you’ll pay for the stock. 
4. GRANT EXPIRATION DATE: ISOs have an expiration date of not more than ten years (or five years if you are a 10% or greater stockholder). You lose your vested options if you haven’t exercised them by the expiration date. If you quit or retire, you must exercise your vested ISOs within 3 months of leaving your job. However, more extended periods apply upon disability or death.   
5. BARGAIN ELEMENT: The difference between the option’s exercise price and the market price when exercised. Remember this term, it is critical for your tax bill.

What Are the ISO Benefits?

ISOs allow you to buy shares of stock at a price below the actual market value. For example, if your company grants you the option to purchase 1,000 shares at an exercise price of $20 per share, but the market value of those shares is $50, you can buy $50,000 worth of stock for $20,000. That’s not a bad deal!

The Tax Advantage:
There are no tax consequences when you receive an ISO grant or when you exercise that option (for regular tax purposes). Instead, you report the taxable income only when you sell the stock. The most significant benefit is the unique tax advantage received when you trigger a Qualifying Disposition.

Qualifying Disposition

A qualifying disposition occurs when you wait to sell shares acquired both 

1. One year after you exercise your ISOs  AND
2. Two years after they were granted.

This results in gains being taxed at the lower long-term capital gains rate (0%, 15%, or 20%) rather than at ordinary income tax rates (which can be as high as 37%).

Disqualifying Disposition of an ISO

Suppose you fail to fulfill either of the waiting period requirements for a qualified disposition. This results in a disqualifying disposition, and you lose the benefit of the lower long-term capital gain rate on the bargain element. Instead, the bargain element is taxed as ordinary income.

By the Numbers: Qualified vs. Disqualified

The chart below illustrates the tax difference between Qualified and Disqualified ISOs.

Assumptions: You exercise 2,000 shares.

• Exercise Price: $10 | Sale Price: $25
• Gross Profit: $30,000
• Your Tax Rates: 32% Ordinary Income | 15% Capital Gains | 3.8% NIIT

*Note: In a disqualified disposition, the bargain element is taxed as wages. The 3.8% Net Investment Income Tax (NIIT) generally does not apply to this wage income.

ISOs and the AMT: Where It Gets Sticky

If there is one thing that ruins an ISO party, it’s the Alternative Minimum Tax (AMT).

Originally, the AMT was designed to stop wealthy people from using too many loopholes to pay zero tax. But today? It’s a dragnet that frequently catches regular higher-income earners, especially if you exercise ISOs.

Here is why the AMT is a problem for ISOs
When you exercise ISOs and keep the shares (holding them past December 31), income is not recognized in the typical tax system.  The AMT, which is a parallel income tax calculation, adds that income back.

For AMT purposes, that bargain element (the paper profit you made at exercise) counts as income immediately.

You are effectively forced to calculate your taxes twice: once under the regular rules and once under the AMT rules. You pay whichever bill is higher.

• The Damage: If you trigger it, the AMT flat tax rate is 26% on the first $244,500 of excess income, and 28% on everything above that.

The Silver Lining

If you do get hit with the AMT, you will eventually get it back, sort of. You’ll receive an AMT Tax Credit that can be carried forward to future tax years. This credit will be applied to lower your regular tax bill in the future. So, although you’ll be on the hook for more income taxes initially, you will get that money back in the future. It’s like you’re giving an interest-free loan to the government.

The 2026 Rules: The “AMT Danger Zone”

This year, the OBBB Tax Bill made the higher AMT exemptions permanent, which sounds great on paper.

• Single filers get a $90,100 exemption.
• Married couples get $140,200.

But here is the catch: The new law made the phaseout rules much more aggressive starting in 2026.

If you are single and your AMT income hits $500,000, or married and hitting $1,000,000, you start losing that exemption fast. And I mean fast. The government now takes away 50 cents of your exemption for every dollar you earn over the limit.

Why We Call It the “Danger Zone”

This created a dangerous window for married couples earning between $1 million and $1.28 million.

If your income falls in that range, you get hit from both sides. You pay the 28% AMT rate and lose your exemption. That double hit results in an effective tax rate jump above 35%. Ouch!!!!!

The SALT Trap

To throw more salt in the wound, the State and Local Tax (SALT) deduction cap bumped up to $40,400 for 2026. That helps your regular tax, but the AMT doesn’t allow SALT deductions. At. All. A larger deduction on your regular return means a more significant gap between your Regular Tax and AMT, which increases the chance of falling into the AMT trap without realizing it.

ISO Example

Holly is married, earns $500,000, and has $50,000 in SALT deductions. She wants to exercise ISOs with a $150,000 paper profit.

• Regular Tax: Her taxable income is roughly $450,000.
• AMT: We have to add back her SALT deduction and that $150k ISO profit. Her income here jumps to $650,000.

The Verdict:
Holly is safe… for now. Since $650k is well under the new $1 million phaseout cliff, she keeps her full exemption.

But watch what happens if she gets aggressive.
If she exercises a massive block of options and pushes her AMT income to $1.1 million, she hits the new “Bump Zone.”

1. She is $100k over the limit.
2. The IRS slashes her exemption by $50,000 (50% of the excess).
3. Suddenly, a significantly larger share of her income is subject to the 28% tax.

Landmines to Watch Out For

1. The $100k Limit

Only $100,000 worth of ISOs can become exercisable in any single calendar year. This is based on the stock’s fair market value on the grant date, not the current fair market value. Once you’ve hit the limit, any additional options that vest convert to Non-Qualified Stock Options (NSOs), which don’t get the same tax treatment. You’ll owe ordinary income tax on those when you exercise.

2. Leaving Your Job?

If you quit or get laid off, you typically have 90 days to exercise your ISOs. Miss that window, and they either expire worthless or convert to NSOs. Disability or death usually extends that window to one year,  but that isn’t very helpful if you’re dead.

3. The “No Withholding” Trap

This one catches people off guard. When you exercise an ISO, your company withholds nothing. Zero,  nada, zip. If you’re caught in the AMT, you may be facing a big tax bill by the following April. Remember to set some cash aside, or better yet, pay quarterly estimated income taxes.

Your Options

There are ways to avoid or further minimize the chance of the AMT.

• The “Same-Year” Escape Hatch: If we sell the shares in the same calendar year you exercise, the AMT disappears entirely. You just pay regular income tax on the profit. Clean, simple, and yes, better than paying the AMT.
• Spread It Out: Instead of exercising everything at once, we split it across multiple years to keep your income below the AMT “bump zone.”
• The January Move: Exercise early in the year. That gives us nearly a full year to watch the stock. If it drops in the fall, we can sell before December 31 and wipe out the AMT liability.

The Bottom Line

ISOs can significantly increase your wealth, but between the qualifying periods, the AMT trigger, and the phaseouts, this is one of the trickiest areas of the tax code. Run the numbers before you click “Exercise.” If you’ve got grants sitting there and aren’t sure where you stand with the new rules, let’s talk. We’ll make sure you actually keep what you’ve earned.

ISOs aren’t for the faint of heart. If you have ISO grants, call us to help you with your strategy.