For employees and US-based NRIs working at early-stage private startups, equity compensation often makes up a meaningful part of the total financial package. One of the most common types of equity grants is the Incentive Stock Option (ISO).

While ISOs offer significant long-term upside, they follow specific IRS tax rules. Understanding how they vest, when to exercise them, and how to sell the shares can help you maximize returns and avoid unexpected tax bills. 

This guide gives a clear overview of how ISOs work, how they differ from other stock options, and what US NRIs and business owners should know about their tax treatment.

What Are Incentive Stock Options (ISOs)?

Incentive Stock Options (ISOs) are employee stock options that can only be granted to employees not contractors or consultants. Their main advantage is favorable tax treatment. Unlike Non-Qualified Stock Options (NSOs), ISOs can allow you to:

• Pay no regular income tax at exercise
• Qualify for long-term capital gains tax on sale, if you meet specific holding periods

This makes ISOs especially attractive for employees and NRIs holding equity in US private companies.

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Key Terminology in ISO Grant Documents

Understanding the terminology in your grant agreement helps you plan both equity and tax outcomes.

1.Option Grant and Vesting

Grant Date: The date the company awards your options.

Vesting Schedule: Determines when you earn the right to exercise your options. A common schedule is four years with a one-year cliff (25% vests after the first year, the rest monthly).

Expiration Date: The last date you can exercise your options, typically ten years from grant.

2.Exercise Price and Spread

Exercise Price (Strike Price): The fixed price you pay per share, based on the 409A valuation at the time of grant.

Spread: The difference between today’s Fair Market Value (FMV) and your exercise price. This number affects both AMT exposure and eventual gains.

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How ISOs Work: The Lifecycle Explained

Grant and Vesting

You owe no tax when options are granted or when they vest. Vesting simply gives you the right to exercise.

Exercising Your Options

Exercising converts vested options into shares by paying the exercise price. This can happen in two ways:

• Cashless Exercise: Selling shares immediately to cover exercise costs
  
  
• Exercise and Hold: Paying cash and holding shares to start the long-term capital gains clock
  
  

Some companies also allow Early Exercise, where you buy shares before they vest.

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ISO Tax Implications for US Employees and NRIs

This is where things get more complex, because ISOs involve two tax systems: Regular Federal Income Tax and Alternative Minimum Tax (AMT).

Regular Tax vs AMT

Under the regular tax system, exercising an ISO doesn’t trigger tax. You pay tax only when you sell the shares.

Under AMT rules, the spread at exercise is treated as income for AMT calculations. In 2025, AMT exemption amounts are:

• $88,100 for single filers
• $137,000 for married filing jointly

If your AMT is higher than your regular tax, you pay the difference. Any AMT paid may later generate a credit.

The AMT Trap

A large spread can lead to AMT even though you haven’t sold the shares or received any cash. This is a common issue for employees and US NRIs exercising late-stage startup stock options.

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Selling ISO Shares: Qualifying vs Disqualifying Dispositions

The tax outcome depends heavily on when you sell relative to the grant and exercise dates.

Qualifying Disposition (Lower Taxes)

You must meet both holding periods:

• Hold at least 2 years from grant
• Hold at least 1 year from exercise

If met, all gain is long-term capital gains.

Disqualifying Disposition (Higher Taxes)

Selling earlier triggers:

• The spread at exercise taxed as ordinary income
• Remaining profit taxed as capital gains
• No AMT if sold in the same year as exercise
  
  

Important ISO Rules for US NRIs and Startup Employees

The 90-Day Post-Termination Window

If you leave your company, you typically have 90 days to exercise vested ISOs. Miss the window and your ISOs may:

• Convert to NSOs (losing ISO tax benefits), or
  
  
• Expire completely
  
  

Some companies provide extended windows, but this must be confirmed in your grant.

The $100k ISO Limit

The IRS limits the amount of ISOs that can become exercisable in one year to $100,000 (based on grant-date FMV). Anything above this automatically becomes an NSO with ordinary income tax at exercise.

This rule commonly affects:

• Senior engineers
• Late-stage startup employees
• Founders with employee-equity grants
• US NRIs receiving sizable grants
  
  

Conclusion

ISOs can generate real wealth, but only if handled thoughtfully. The timing of exercise, potential AMT exposure, and required holding periods all play a role in your final tax outcome. For US-based NRIs and NRI business owners, cross-border reporting and residency changes add another layer of planning.

Before exercising a large number of options, it’s wise to run tax scenarios or consult a professional. Platforms like iNRI can help NRIs streamline US–India compliance and equity management.

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Frequently Asked Questions (FAQs)

1. Do I have to pay taxes immediately when I exercise ISOs?

Under regular federal tax rules, you don’t owe taxes at exercise. But the difference between FMV and your exercise price counts toward AMT. If the spread is high enough, it can trigger an AMT bill even though you haven’t sold the shares. If you do pay AMT, you may receive credits in future years.

2. What happens to my ISOs if I quit my job?

You generally have a 90-day window after your last day to exercise vested ISOs. If you don’t, they typically expire or convert to NSOs. Some companies extend this window, so it’s worth reviewing your grant agreement before leaving, especially for US NRIs planning a move or job transition.

3. What is the difference between a qualifying and disqualifying disposition?

A qualifying disposition meets the two required holding periods (2 years from grant and 1 year from exercise), giving you long-term capital gains. A disqualifying disposition happens when you sell earlier, which means part of your gain is treated as ordinary income. If you sell in the same year as exercise, AMT does not apply.

4. Can I exercise my options before they vest?

Some companies allow early exercise, where you buy shares before they vest. If you choose this, filing an 83(b) election within 30 days helps fix your taxable basis at a lower value and can reduce taxes later. This strategy is often useful for employees and NRIs at early-stage startups.

5. What is the $100k ISO limit?

The IRS restricts how many ISOs can become exercisable in a single year to $100,000 based on grant-date FMV. Anything above this is treated as an NSO, which is taxed as ordinary income at exercise. This matters for employees with large grants, founders with employee-equity packages, and US NRIs receiving significant stock option allocations.

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