Incentive Stock Option (ISO) Taxes: A Guide

January 21, 2025 • Chris Kawashima • Hayden Adams

Incentive Stock Option (ISO) taxes can be complex to navigate. This ISO tax guide explains the basics of how ISOs are taxed and what documents are needed to file in the U.S.

If you've received incentive stock options (ISOs) from your employer, it gives you the right —but not the obligation—to buy shares of your company's stock at a specific price. As your company's value increases so may the value of your options.

One benefit to ISOs is their favorable tax treatment. However, navigating ISO taxes can be complex. This guide helps you understand the taxes on your ISOs and what documents you or your tax advisor will need to file in the United States.

ISO overview

For ISOs, your employer will issue you stock options on a specific date (known as the "grant date.") Generally, you will not be able to exercise (purchase or sell) stock until the end of a predetermined waiting schedule (known as the "vesting period.") Once your options are vested, you have the right to exercise options at a fixed price (the "strike price" or "award price") set when you were granted the options.

How do ISO taxes work?

ISOs are typically taxed when you sell the stock, not at the exercise date. However, in some jurisdictions such as Pennsylvania and Ohio, local taxes can apply at exercise (see below section on AMT). In general, the tax treatment for ISOs depends on how long you hold the shares before selling them. Depending on this time period, the sale (known as "disposition") will be classified as either a qualified disposition or disqualified disposition.

Qualified dispositions give you a more favorable tax treatment. To be a qualified disposition, you must meet two holding period requirements before selling the shares:

The sale must be more than one year from the exercise date (i.e. the date you purchased the shares).
The sale must be more than two years from the grant date.

If both of these requirements are met, the gain realized from the sale of the shares will be eligible for taxation at the lower long-term capital gains tax rate. The taxable gain will be the difference between the strike price and the fair market value (FMV) when the shares are sold.

Disqualified dispositions don't qualify for preferential tax treatment since you sold the stock before meeting both holding period requirements listed above. With disqualified dispositions, you are taxed at ordinary income tax rates on the difference between the strike price and the FMV on those shares when you exercise. Any additional gains realized over the FMV will be taxed as a capital gain or loss depending on how long the shares were held after the exercise date.

Alternative minimum tax and ISOs?

While exercising an ISO doesn't trigger ordinary income taxes, it can potentially trigger the alternative minimum tax (AMT). As the name states, the AMT is an alternative way to calculate federal income taxes. Generally, AMT impacts high-income taxpayers, but it can also impact any taxpayers who exercise and hold a significant number of ISOs. Triggering AMT means that you may have to pay additional taxes in the year of the exercise. (Note: Consider talking with your tax advisor about using AMT credits in future years.)

If you believe that AMT could impact your ISO exercise, we recommend consulting with a tax professional before exercising your options to ensure you don't have additional taxes due.

ISO tax documents

ISO tax rules are complex, and we always recommend consulting with a tax advisor before taking any action or filing a tax return.

Here's an overview of the documents you may need when you're filing taxes and how you or your tax advisor will use them.


Document	Why you need it	When to use it	Where you get it
Form W-2	In addition to your wages, generally, this form includes the taxable ordinary income from selling your ISO.	To report taxable compensation after selling ISO shares.	Your employer will provide it during tax season.
Form 3921	Form includes details of the ISOs stock purchase.	To help report income from the sale of ISO shares.	You may receive this form from your employer, broker, or a third party for the year of purchase.
Form 1099-B	Form that reports proceeds from investment sales.	To help calculate stock sale gains/losses when preparing your tax return.	From the broker that managed the stock sale (e.g., Charles Schwab).
Schedule D; Form 8949	Forms where you detail the gains/losses from Form 1099-B and calculate capital taxes due.	To help calculate and report on stock sales capital gains/losses when you prepare your taxes.	From the IRS.
Form 1040	Form you use to report income to the IRS.	When reporting annual taxes–you'll report award income and gains/loss from sale on the form.	From the IRS.

What is cost basis and why is it important?

Calculating how much you gained or lost from the sale of stock depends on your cost basis. When you acquire the stock through an ISO, your stocks cost basis is generally equal to the fair market value at the time of the exercise date (i.e. the cost basis is equal to the strike price of the ISO). Your cost basis may need to be further adjusted if the shares are sold in a disqualified disposition. Using the correct cost basis ensures that you file correctly and aren't taxed more than the required amount. Refer to Schwab's cost basis sheet to help you determine the cost basis on your stock plan transactions so you can file your taxes accurately.

Be sure to meet with a tax professional to discuss your specific situation before filing your taxes.

Stuck with questions? Call 800-654-2593 any time Monday through Friday to get answers to your equity award questions.

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