What is the $100k rule? A guide to the ISO/NSO split

Stock options can be one of the most valuable parts of your compensation package, but they come with complex tax rules that might catch you off guard. One rule affects almost anyone who has a substantial options grant: the $100k limit (a.k.a., $100k rule or ISO/NSO split).

This rule determines whether your options qualify as Incentive Stock Options (ISOs) or get converted to Non-Qualified Stock Options (NSOs).

Understanding how it works will help you plan better and avoid surprises when it’s time to exercise.

What are ISOs and NSOs (refresher)

Both Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs) are types of employee stock options, meaning that they give the right to purchase stock at a predetermined price (your strike price). The key difference between them is how they’re taxed.

• ISOs offer preferential tax treatment. When you exercise them, you don’t owe ordinary tax income immediately. In fact, if you hold the shares for long enough any gains are taxed as long-term capital gains – meaning at a lower rate than your regular income tax
• NSOs are taxed differently. When you exercise them, the difference between your strike price and the current fair market value (FMV) is taxed as ordinary income immediately. You’ll also owe capital gains tax on any additional appreciation when you eventually sell the shares

What is the $100k rule?

The rule exists to limit the tax benefits of ISOs – by capping how much can vest as ISOs each year, it ensures that larger option packages still generate ordinary income tax revenue through the NSO portion.

Here’s how it works: only $100,000 worth of stock options can vest as ISOs in a single calendar year. Anything above that threshold is automatically converted to NSOs.

There are a few things to keep in mind:

• Vesting schedule determines the split. The rule applies based on how many options vest each calendar year. Within any year, the first $100k to vest are ISOs, and everything beyond that automatically becomes NSOs.
• The limit resets annually. The cap resets every year on January 1st, as it’s a per calendar-year calculation.
• It happens automatically, in vesting order. You don’t get to pick which options stay ISOs and which turn into NSOs.
• Early exercise affects split upfront. With early exercisable options, the entire grant counts toward the $100k limit in the grant year, potentially creating more NSOs immediately.

Breaking down the numbers (examples)

The best way to understand how it all works is to see it in action – let’s walk through a few common scenarios to show you how the calculations work and when you’re likely to end up with a mix of ISOs and NSOs.

Example #1 - staying under the limit

Let’s say you received 50,000 options on January 1st 2024, at a fair market value (FMV) of $5 per share (this is the same as the strike price at grant). The options vest over 4 years with a standard schedule, i.e., 25% after one year, monthly after that.

Total grant value: 50,000 * $5 = $250,000

Since only $62,500 worth of options vest each year, you stay under the $100k annual limit, and all 50,000 options remain ISOs.

Example #2 - exceeding the limit

You received 50,000 options on January 1st 2024, at a FMV of $12 per share. The options vest over 4 years with a standard schedule, i.e., 25% after one year, monthly after that.

Total grant value: 50,000 * $12 = $600,000

Since $150,000 worth of options vest each year, you exceed the $100k limit. Each year, approximately 8,333 options stay as ISOs, while the remaining 4,167 automatically become NSOs.

Example #3 - multiple grants

You have two options grants from the same company:

1. Grant A (January 1st, 2023) – 15,000 options at $8 FMV = $120,000 total value
2. Grant B (January 1st, 2024) – 20,000 options at $10 FMV = $200,000 total value

In 2025, there are portions of both grants that are vesting.

The combined value is only $80,000, meaning all of the vesting options for 2025 remain ISOs. Grant A gets priority because it was granted first.

In 2026, you get a new grant and more options vest:

1. Grant C (January 1st, 2026) – 10,000 options at $5 FMV = $150,000 total value

Early exercise and the $100k rule

Some companies offer early exercise options, which allow employees to exercise options before they vest. This can be attractive for tax planning purposes, but it has a significant impact on how the $100k rule applies.

With early exercisable options, the entire grant is treated as exercisable in the year that it’s granted. This means that if you receive a grant of 50,000 options at a $5 FMV with early exercise rights, all $250,000 counts towards the $100k limit in year one. Only the first $100k would qualify as ISOs, and the remaining $150k would be NSOs from day one.

What this means for your equity

Understanding how the $100k rule works can have real financial implications for how you manage your equity compensation. When part of your grants convert to NSOs, your tax bill changes significantly, potentially costing you tens of thousands of dollars. For instance:

• Exercise timing becomes strategic. The tax treatment differs between ISOs and NSOs, meaning you’ll need to evaluate when to exercise each type based on your individual circumstances.
• Cash flow planning is key. NSO exercise required money for both the shares and tax withholdings on the spread. Without knowing, you could face unexpected upfront costs.
• Alternative Minimum Tax (AMT) adds complexity. ISOs can trigger AMT at exercise, which combined with NSOs’ ordinary income implications means you need to carefully model different scenarios. Make sure you review your particular circumstance with your tax advisor.

How to navigate the $100k rule

1. Review your option grant documents to understand if you might be impacted by the ISO/NSO split
2. Consult with a professional who specializes in equity compensation to help you optimize your strategy. Book a call with one of our advisors here.
3. Track your equity over time. Company valuations change and future grants may behave differently than your current ones. Sign up or log in to our platform to track your equity and get the latest valuation insights.

The $100k rule can significantly impact your financial outcome, so once you understand how it works you can plan accordingly. Your future self, and your tax bill, will thank you.