What’s the Difference Between ISO and NSO Stock Options?

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If you’re a startup employee with stock options, you’ve probably come across the terms ISO (Incentive Stock Options) and NSO (Non-Qualified Stock Options). These terms might sound technical, but understanding the difference is crucial for making informed decisions about your equity.

This guide breaks it all down clearly and simply, covering what each type of stock option is, how taxes play a role, and how they impact your financial situation. Plus, we’ll discuss how solutions like Equitybee can help you fund your stock options.

By the end, you’ll feel more confident navigating ISO and NSO stock options and deciding what to do with yours.

What Are ISOs and NSOs?

Both ISO and NSO stock options give you the ability to purchase a set number of company shares at a predetermined price (called the strike price) after your options vest. This allows you to own a portion of the company you’ve helped build. However, the two differ significantly in terms of eligibility and tax treatment.

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Key Difference

The biggest difference between ISOs and NSOs lies in who can receive them and how they’re taxed. ISOs are generally more favorable tax-wise but come with stricter requirements, while NSOs are more accessible but come with higher tax liabilities.

Tax Implications of ISO vs NSO

Taxes play a huge role in deciding how to handle your stock options, especially given how complex and expensive the process can be. Here’s a closer look at how taxes work with each:

Tax Example

Imagine you have:

• 5,000 vested shares
• Strike price: $2.00 per share
• Current Fair Market Value (FMV): $10.00 per share

If you have ISOs:

• There’s no income tax owed at the time of exercise, but the $40,000 spread may trigger AMT if your full taxable picture indicates liability.
• If the shares are sold too early (before meeting the required holding periods), the favorable, long term capital gains tax treatment may be lost.

If you have NSOs:

• The difference between the FMV and strike price creates a taxable event upon exercise.
• Ordinary income tax is owed on this amount:

 5,000 × ($10 - $2) = $40,000 taxable income

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Why Understanding Tax Triggers Matters

The exercise process for both types can create surprising tax implications. Many employees are blindsided by the costs, leading to difficult decisions about whether to exercise at all.

But you don’t have to go it alone. Solutions like Equitybee provide funding that helps you cover both exercise costs and taxes without taking on personal risk to exercise your options.

ISO vs NSO in Real Life

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Scenario 1: Sarah with NSOs

Sarah works at a startup and holds Non-Qualified Stock Options (NSOs). She decides to exercise 2,000 shares at a strike price of $2.00, while the current Fair Market Value (FMV) is $12.00/share.

• Taxable income at exercise:
  2,000 × ($12.00 - $2.00) = $20,000
  This amount is taxed as ordinary income.
  
  
• Future tax:
  If she sells the shares later at a higher price, the additional gains will be taxed as capital gains (short- or long-term depending on how long she holds the shares after exercise).
  
  

Scenario 2: John with ISOs

John holds Incentive Stock Options (ISOs) at a startup that’s been steadily growing. He decides to exercise 1,000 shares with a strike price of $1.00, and the FMV is $10.00/share.

• Cost to exercise:
  1,000 × $1.00 = $1,000
  
  
• No income tax is due at exercise, but the $9,000 spread (1,000 × [$10 - $1]) may trigger AMT depending on his overall tax situation.

John holds the shares for over 1 year post-exercise and 2 years from the grant date, meeting the ISO holding requirements.

• When he sells at $20.00/share, his $10,000 profit (1,000 × [$20 - $10]) is taxed at long-term capital gains rates, which are typically lower than ordinary income tax.

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How Equitybee Can Help With ISOs and NSOs

Equitybee is here to make funding the exercise of your stock options stress-free. Here’s how it works:

1. Apply through Equitybee’s platform.
2. If approved, investors can cover your exercise and tax costs.
3. You become a shareholder without risking your personal savings.
4. If your company exits (or there's another liquidity event), you share a portion of the proceeds with the investors who funded your options. If there’s no exit? You owe nothing.

Why Choose Equitybee?

• No personal financial risk to exercise your options: You don’t take on debt or owe anything if your company doesn’t exit.
• Flexible for all option types: Whether you hold ISOs or NSOs, Equitybee can help you fund them.
• Keep your equity: You retain full ownership of your shares.

Make the Most of Your Stock Options

ISOs and NSOs may seem complex, but understanding their differences is the first step in building a plan for your equity. Remember:

• ISOs offer tax advantages but come with specific requirements.
• NSOs are more common but often costlier in terms of taxes.
• Both require planning, especially when it comes to exercising.

Instead of letting costs stop you from owning your hard-earned equity, explore funding options like Equitybee. With over $120 million funded and support for 2,500+ employees, we’ve already helped people like you become shareholders in companies like SpaceX, Stripe, Reddit and many others.

Don’t let the cost of exercising hold you back. 
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_{*Equitybee does not offer tax advice and encourages you to speak with your tax adviser about the impact on your specific tax situation.}

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