When to Exercise Stock Options at a Startup: A Decision Framework

Knowing when to exercise your stock options is one of the most consequential financial decisions you'll make as a startup employee. Exercise too early and you tie up cash in a company that might fail. Wait too long and you face a crushing tax bill — or lose the options entirely when you leave.

In 60 seconds:

• NSOs generally trigger ordinary income at exercise; ISOs can qualify for capital gains treatment but can also trigger AMT.
• An earlier exercise can acquire shares at a lower current FMV and start relevant holding periods sooner. It does not lower an existing option’s strike price, which is set by its terms.
• Waiting reduces cash risk, but can increase the tax bill and risk forfeiture if you leave before you can exercise.
• Washington’s capital-gains tax applies 7% to the first $1 million of Washington taxable capital gains and 9.9% above that amount, after applicable exclusions and deductions. The $278,000 standard deduction is the 2025 figure, not a fixed amount for later years. Beginning in 2028, separately compute Washington income tax, including the shared $1 million deduction for spouses and registered domestic partners, the §302 capital-gain adjustments and §205 credit. Do not simply add both headline state rates.

This guide gives you a framework for making the decision. It covers the five main exercise strategies, the tax implications of each, how Washington state's new taxes change the calculus, and what to do when you're running out of time.

The Five Exercise Strategies

There's no universal right answer. The best strategy depends on your company's stage, your cash position, your tax situation, and your confidence in the outcome. Here are the five approaches, ranked roughly from earliest to latest.

1. Early Exercise at Grant (Before Vesting)

If the plan permits early exercise, you can buy shares before the option is vested. The shares remain subject to the agreement’s vesting and repurchase terms. Compare actual transfer-date FMV with the strike; a grant-date appraisal does not guarantee zero spread on a later exercise.

An early exercise transfers unvested shares only if the plan permits it. A timely §83(b) election measures the transfer-date FMV minus the amount paid; zero spread must be established, not assumed from the grant date. For NSOs it generally fixes §83 compensation at transfer. For ISOs its relevant effect is generally on AMT; it does not override ISO disposition rules. File within 30 days after the actual share transfer, subject to applicable statutory deadline rules. See the §83(b) guide.

Why this works:

• If actual FMV equals the amount paid and the relevant election is effective, the elected spread is zero. Near-zero spread is not literally zero.
• Later appreciation can receive capital-gain treatment, but ISO disqualifying dispositions and the actual holding periods still matter.
• The stock holding period depends on actual acquisition and applicable §83 rules, not merely the option grant date.
• For eligible QSBS, determine the stock acquisition date and the applicable three-, four-, five- or more-than-five-year holding period; owning an unexercised option does not itself start the stock holding period.

The risks:

• You spend real money on shares that might become worthless.
• If you leave before vesting, the company repurchases your unvested shares — usually at the price you paid, but you don't get a tax refund on the 83(b) election.
• Not all companies allow early exercise. Ask.

Best for: Employees who join early (when the strike price is low), who have the cash, and who have high conviction in the company.

2. Exercise Shortly After Vesting Begins

If early exercise is unavailable or unsuitable, consider exercising vested portions as they become exercisable. Check actual FMV each time; an early-stage company’s share value can rise or fall substantially.

Tax implications:

• For qualifying ISOs exercised into vested shares and held past year-end, the spread generally creates an AMT adjustment. Model the full return; a spread smaller than the exemption does not itself establish zero AMT.
• For typical NSOs exercised into vested shares, the spread is compensation. Employee and contractor reporting differ.

Best for: holders who can fund the exercise and taxes after considering the spread, number of shares and downside risk. A single-digit per-share value alone does not establish affordability.

3. Exercise Strategically Over Multiple Years

Spreading exercises across tax years can help manage AMT or ordinary compensation, but future share values, income and deadlines may change. Model each year; the strategy does not guarantee staying below a threshold.

Key thresholds to manage around:

• AMT exemption phase-out: $500,000 AMTI for single filers in 2026. Stay below this to keep your full exemption.
• Washington’s 2028 income tax uses its statutory income base and deductions, including one shared $1 million deduction for spouses and registered domestic partners. Gross salary alone is not the tax base.
• For 2026 single filers, the 35% federal bracket begins above $256,225 of taxable income and 37% above $640,600. These are marginal brackets, not rates on the entire exercise. See Rev. Proc. 2025-32, §4.01.

Best for: Employees with large grants, especially those who can forecast their income across multiple years.

4. Exercise When Liquidity Is Imminent

Waiting until a potential IPO, listing or acquisition is closer can reduce the time capital is at risk. Confirm whether the transaction will actually permit a sale, cashless exercise or cash-out; an announcement or filing is not a guarantee.

The appeal is better visibility into potential liquidity. Deals can fail, stock prices can fall, and restrictions can leave you unable to sell after exercising.

The problems:

• The spread at exercise will be large — potentially hundreds of thousands or millions of dollars.
• A large NSO spread can create substantial compensation income. An ISO exercise-and-hold can create AMT; a same-year sale generally removes the separate exercise adjustment.
• Review the actual lock-up, trading restrictions, registration status and company sale procedures. An IPO filing does not start a universal six-month resale clock, and tax-payment obligations may arise before a permitted sale.
• Beginning in 2028, taxable NSO compensation can enter Washington’s income-tax base. A qualifying ISO exercise-and-hold generally does not create ordinary income in federal AGI; a subsequent disqualifying sale can.
• A sale shortly after acquisition may fail the applicable QSBS holding period. That is separate from whether the shares meet original-issuance and issuer eligibility tests; later-regime partial exclusions begin at three years.

Best for: holders seeking better visibility into liquidity who can still bear the risk that sale proceeds arrive late or never.

5. Never Exercise (Let Options Expire)

Allowing options to expire can be a deliberate choice when exercise cost and tax risk outweigh expected value. It can also result from missed deadlines or insufficient cash. No reliable percentage of all startup options is established here.

The objective is an informed decision before the deadline. Exercising is not automatically preferable to letting an option expire.

If you've already let options expire — you're not alone, and you're not out of options for the future. Here's what typically goes wrong and how to avoid it:

A contractual post-termination deadline can arrive quickly. Confirm the exact date before leaving and calculate strike price times exercisable shares, plus taxes. Do not assume every agreement uses 90 days.

The company may never provide liquidity. Not exercising avoids the exercise outlay and related tax risk, although the option may then expire without value.

Before deciding, compare exercise cost, taxes, company prospects and contractual deadlines. A partial exercise or an authorized extension may help, but neither guarantees a favorable result. Review an extension’s plan, approval and tax consequences before relying on it.

Exercise Methods: How You Actually Pay

Once you've decided when to exercise, you need to decide how to fund it.

Cash exercise. You pay the exercise price in cash if permitted by the plan. Exercising 10,000 shares at $2 requires $20,000, plus any taxes and fees.

Cashless exercise through a sale. An available, permitted sale can fund the strike price and taxes from proceeds. Confirm the buyer or broker, company consent, timing, fees and tax withholding; a public listing is not a universal prerequisite or guarantee.

Net exercise. If the plan permits it, the company reduces the delivered shares to cover the exercise price. This differs from selling shares to an outside buyer. Confirm tax treatment and whether a separate cash tax payment is required.

Exercise financing. Review the actual loan or funding contract, recourse, fees, proceeds sharing, transfer restrictions and downside allocation. Different financing products have different economics and tax consequences; do not assume every arrangement is a high-interest loan.

The Tax Decision Tree

Tax treatment depends on award type, vesting, exercise and sale dates, elections, service relationship and residency, as well as the rest of the return.

ISOs — exercise and hold (qualifying disposition):

• No regular income tax at exercise.
• The spread is an AMT adjustment — you may owe federal AMT.
• At sale (if you've held 2+ years from grant, 1+ year from exercise): gain is long-term capital gains.
• Washington’s capital-gains tax applies 7% to the first $1 million of Washington taxable capital gains and 9.9% above that amount, after applicable exclusions and deductions. The $278,000 standard deduction is the 2025 figure, not a fixed amount for later years. Beginning in 2028, separately compute Washington income tax, including the shared $1 million deduction for spouses and registered domestic partners, the §302 capital-gain adjustments and §205 credit. Do not simply add both headline state rates.

ISOs — exercise and sell same year (disqualifying disposition):

• The compensation portion is generally the exercise spread, limited under §422(c)(2) for qualifying sales below exercise-date FMV. Additional gain can be capital gain.
• No AMT adjustment.
• Beginning in 2028, apply Washington’s income base, residency and sourcing rules, deductions and credits to taxable compensation and other amounts.

NSOs — exercise:

• For a typical NSO exercised into vested shares, the spread is compensation at exercise. For unvested shares, §83 and any timely §83(b) election determine timing.
• Beginning in 2028, apply Washington’s statutory income base and deductions, including the shared spouse/registered-domestic-partner deduction.
• Post-exercise appreciation is capital gains when you sell.

For taxable compensation recognized before January 1, 2028, Washington’s new income tax is not yet effective. Distinguish the events:

• A disqualifying ISO sale completed before 2028 generally recognizes compensation before the new income tax begins. A 2027 exercise alone does not shelter a disqualifying sale in 2028.
• Typical NSO compensation recognized in 2027 is outside the new Washington income tax; later sale gain has separate rules.
• For unvested shares, a valid §83(b) election can affect recognition timing. It does not exempt every later event from Washington tax.

Compare actual recognition years under the Washington base and deduction rules. A qualifying ISO exercise-and-hold generally produces no ordinary income in federal AGI after 2027 either. Do not accelerate every exercise solely because 2028 is approaching.

When You're Leaving: The Post-Termination Exercise Period

Departure can trigger a contractual deadline. Identify the exact option expiration date and the separate ISO tax deadline.

The option agreement and plan set contractual expiration; 90 days is a common convention, not a universal rule. Separately, §422(a)(2) generally requires exercise within three calendar months after employment ends to retain ISO treatment. Ninety days does not always fit within three calendar months. The statutory disability rule extends the period to one year; §421(c)(1)(A) provides the estate/heir exception. Later exercise, if contractually permitted, generally receives NSO treatment. An extension must be reviewed for authorization and modification consequences.

An extended exercise period may be negotiable under the plan, subject to the option’s maximum term and proper authorization. It can reduce immediate cash pressure but may affect ISO status and other tax treatment. Do not assume an extension is available.

What to do if you're facing the 90-day clock:

1. Calculate the exercise cost. Strike price × vested shares. Can you afford it?
2. Calculate the tax cost. For ISOs, estimate the AMT. For NSOs, estimate the ordinary income tax on the spread.
3. Assess the company's prospects. Is a liquidity event likely in the next 2–3 years? If not, the expected value of exercising may not justify the cash outlay.
4. Ask whether an extension is available and which authorizations or amendments it requires. Review modification, ISO and §409A consequences before changing the award.
5. Consider a partial exercise based on cost, current spread, contractual expiration, issuer eligibility and risk. An unexercised option’s age does not itself advance the QSBS stock holding period.

The QSBS Factor

The issuer must be an eligible domestic C corporation satisfying original-issuance, active-business, redemption and other requirements. For stock issued after July 4, 2025, the gross-assets ceiling is $75 million, indexed after 2026; the earlier ceiling is $50 million. Apply the statutory historical and immediately-after-issuance tests, including issuance proceeds; company valuation is not the asset test. See the QSBS guide. Qualifying stock acquired after July 4, 2025 can receive a 50%, 75% or 100% exclusion after at least three, four or five years. Stock acquired on or before that date generally requires more than five years, with acquisition-vintage rules determining the percentage. The eligible-gain ceiling is the greater of the remaining applicable dollar limit ($10 million for the earlier regime; $15 million for the later regime, indexed after 2026) or ten times qualifying original-issuance basis for shares sold that year. This is a gain limit, not a dollar-for-dollar tax saving. Acquisition dates account for statutory holding-period rules; they are distinct from issuance dates. Gain excluded federally under §1202 generally also stays outside Washington’s capital-gains starting point.

For exercised stock, determine when shares were actually acquired and how §83, any election and statutory holding-period rules apply. An option grant alone does not start the QSBS stock holding period.

Earlier qualifying stock acquisition can start the applicable holding period sooner. It remains a capital-at-risk decision, not a guaranteed tax-free exit.

A Decision Checklist

Here's how to think through the exercise decision:

Step 1: Know what you have. What type of options (ISO vs. NSO)? How many are vested? What's the current 409A value? When do they expire?

Step 2: Calculate cash needed for exercise, projected taxes and fees. Model the full federal and state returns and payment schedule; multiplying the entire NSO spread by one marginal rate can overstate or understate the result.

Step 3: Assess the company. What's the realistic probability and timeline for a liquidity event? A company about to go public is a very different situation from a Series A startup with a long road ahead.

Step 4: Check original issuance, issuer tests and acquisition-regime holding periods. Determine the eligible-gain ceiling and exclusion percentage rather than assuming every share needs exactly five years.

Step 5: Model Washington taxes under actual recognition years, residency, sourcing, base adjustments, deductions and credits. A qualifying ISO exercise-and-hold differs from NSO compensation and a later share sale.

Step 6: Plan for the worst case. What happens if the company fails? Can you afford to lose the exercise price? If the answer is no, exercise less or wait for more certainty.

Frequently asked questions

What happens to stock options when you leave a startup?

Your option agreement and plan control whether, and for how long, vested options remain exercisable after departure. Some use 90 days; others differ. Confirm the exact contractual expiration and separately check the ISO tax deadline before leaving.

How long do I have to exercise stock options after leaving?

The option agreement and plan set contractual expiration; 90 days is a common convention, not a universal rule. Separately, §422(a)(2) generally requires exercise within three calendar months after employment ends to retain ISO treatment. Ninety days does not always fit within three calendar months. The statutory disability rule extends the period to one year; §421(c)(1)(A) provides the estate/heir exception. Later exercise, if contractually permitted, generally receives NSO treatment. An extension must be reviewed for authorization and modification consequences.

What is the 90-day rule for stock options?

The contractual 90-day exercise window and the ISO three-calendar-month tax condition are separate. Ninety days does not always fit within three calendar months. The tax condition does not itself cancel an option; later exercise may be allowed by the plan but generally receives NSO treatment, subject to statutory exceptions.

Do I owe taxes when I exercise stock options?

For typical NSOs exercised into vested shares, FMV minus strike price is compensation; employee and contractor reporting differ. A qualifying ISO exercise-and-hold generally creates no regular income at exercise but can produce an AMT adjustment. A same-year sale generally removes that separate adjustment. Unvested shares require §83 analysis. Washington taxable compensation, capital gains, residency and sourcing must be analyzed separately.

What is early exercise and should I do it?

Early exercise means acquiring shares before vesting when the plan permits. Determine the actual spread and consider a §83(b) election within 30 days of share transfer, subject to applicable deadline rules. NSO compensation and ISO AMT differ. Zero spread is not automatic; future capital-gain treatment and QSBS benefits depend on separate requirements. Review repurchase terms and the cash at risk.

What is the AMT and how does it affect ISO holders?

AMT is a parallel federal tax calculation. For a qualifying ISO exercised into vested shares and held past year-end, the spread generally creates an adjustment. A same-year sale generally eliminates the separate exercise adjustment; a later-year sale does not erase it. AMT owed depends on tentative minimum tax versus regular tax for the entire return. Review estimated-tax and withholding requirements during the year.

Key Takeaways

The biggest mistake startup employees make with stock options is not making a decision at all — letting the options sit until they expire or until a forced timeline (like a 90-day PTEP) creates a bad decision under pressure.

The second biggest mistake is exercising everything at once without understanding the tax consequences — especially the AMT for ISO holders.

Plan early, model the outcomes and make a deliberate choice. The pre-2028 window can matter for taxable compensation, but is not a universal ISO exercise deadline.

Joe Wallin is a startup attorney at Carney Badley Spellman in Seattle. He advises founders, investors, and employees on equity compensation, QSBS, and Washington state tax planning. For more on equity compensation, visit the equity compensation resource page.

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This post is for educational purposes only and is not legal or tax advice. Consult a qualified attorney about your specific situation.