Stock Options at a Private Company: How They Are Taxed and What to Know Before You Exercise
The quick answer
Stock options at a private company are taxed under the same federal rules as at a public company: non-qualified stock options (NSOs) create ordinary income at exercise, and incentive stock options (ISOs) can trigger the alternative minimum tax (AMT). The big difference is liquidity. At a private company, you usually can't sell shares to cover the exercise cost or the tax, so you may pay out of pocket for stock you can't sell. Private company employees also have planning tools that public company employees don't, including early exercise, the 83(b) election, and potentially the qualified small business stock (QSBS) exclusion.
How are private company stock options different?
Private companies offer the same two types of options as public companies: NSOs and ISOs. What changes is how the shares are valued and when you can sell them.
Valuation comes from a 409A appraisal: With no stock market price, private companies hire an independent firm to set the fair market value of their common stock. This 409A value is used to set your exercise price and to calculate the taxable spread when you exercise.
You usually can't sell right away: Shares in a private company generally can't be sold until a liquidity event, such as an acquisition, an IPO, or a company-approved tender offer. That means exercising often requires cash for both the exercise price and any tax owed.
The value is uncertain: A 409A value is an estimate. If the company struggles or never goes public, shares you paid for, and paid tax on, could be worth little or nothing.
How are NSOs taxed at a private company?
When you exercise NSOs, the spread between the 409A value and your exercise price is taxed as ordinary income. It appears on your W-2 and is subject to income tax, Social Security, and Medicare. Because you can't sell shares to cover it, your employer may require you to pay the withholding in cash.
When you eventually sell, any gain above the 409A value at exercise is a capital gain. Hold more than one year after exercise for long-term rates.
Example: You exercise 10,000 NSOs with a $1 exercise price when the 409A value is $5.
Cash to exercise: $10,000
Ordinary income: ($5 - $1) x 10,000 = $40,000, taxed now
Company is acquired two years later at $15 per share: ($15 - $5) x 10,000 = $100,000 long-term capital gain
How do ISOs and AMT work at a private company?
ISOs work the same way as at a public company: no regular income tax at exercise, but the spread counts toward the alternative minimum tax (AMT). The risk is greater at a private company because you may owe AMT on shares you can't sell.
When you sell:
Held long enough: if you sell more than 2 years from grant and 1 year from exercise, the entire gain is taxed at long-term capital gains rates.
Sold sooner: the spread at exercise is taxed as ordinary income, and any gain above that is a capital gain.
Example: You exercise 10,000 ISOs at $1 when the 409A value is $5.
Cash to exercise: $10,000
Regular income tax: $0
AMT income: $40,000, which may create an AMT bill due next April
Company is acquired later at $15, holding periods met: $140,000 long-term capital gain
If the company's value falls after you exercise, you may have paid AMT on gains that never materialize.
What is early exercise and the 83(b) election?
Some private companies let you exercise options before they vest, called early exercise. You then file an 83(b) election with the IRS, which tells the IRS to measure any taxable spread at the time of exercise rather than when the shares vest. For ISOs, the election applies for AMT purposes.
If you early exercise when the exercise price equals the 409A value, the spread is zero, so there is little or no tax due. Your capital gains holding period also starts right away.
The 83(b) election must be filed within 30 days of exercise. There are no extensions. Miss the deadline and you may owe tax as each batch of shares vests.
The risk: You pay cash up front for shares that may never be worth more than you paid. If you leave before vesting, the company typically buys back unvested shares at your cost.
What is QSBS and does it apply to stock options?
Qualified small business stock (QSBS), under Section 1202 of the tax code, can exclude some or all of your gain from federal tax when you sell. For stock issued after July 4, 2025, 50% of the gain can be excluded after three years, 75% after four years, and 100% after five years, up to a cap of $15 million or 10 times your cost basis, whichever is greater. Stock issued before that date generally requires a five-year hold, with a $10 million cap.
The holding period starts when you exercise and own the shares, not when you receive the options. The company must also meet requirements, such as being a U.S. C corporation below a certain asset size in an eligible industry. Ask your company whether its stock is expected to qualify, and note that not every state follows the federal QSBS exclusion.
What happens to private company options when you leave?
Most plans give you 90 days after leaving to exercise vested options, or they expire. At a private company, that can force a large decision: pay cash and possibly tax for shares you can't sell, or walk away from them.
Some companies offer extended exercise windows of several years. That flexibility helps, but ISOs exercised more than three months after you leave are treated as NSOs for tax purposes.
Do state taxes affect private company options?
Yes. Most states tax option income on top of federal tax, and rules vary. Some states don't follow the federal QSBS exclusion, and if you move while your options are vesting, more than one state may tax part of the income. Check your situation with a licensed tax professional before exercising or selling.
Common private company stock option mistakes
Missing the 83(b) deadline: The 30-day window is strict, and missing it can mean paying tax as shares vest, often at higher values.
Exercising ISOs without modeling AMT: A large exercise can create a tax bill on shares you can't sell to pay it.
Waiting until you leave to decide: A 90-day window after leaving leaves little time to plan or raise cash.
Overcommitting cash: Putting too much of your savings into illiquid company stock can leave you without flexibility if the company struggles.
Assuming QSBS applies: Not every company or share qualifies. Confirm with the company and a tax professional.
What should you do when you receive private company options?
Read your grant agreement: Confirm whether you have NSOs or ISOs, the vesting schedule, the expiration date, and the post-departure exercise window.
Ask about early exercise: Find out whether your plan allows it and what the current 409A value is.
Estimate the cash and tax: Calculate the exercise cost, the ordinary income or AMT impact, and state tax before you act.
Decide how much to invest: Treat exercising as an investment in one illiquid company and set a limit you're comfortable with.
Track key documents: Keep your grant agreements, 83(b) election with proof of filing, and Form 3921 for ISO exercises.
Frequently asked questions (FAQ)
Can I sell private company stock before an IPO? Sometimes. Some companies run tender offers or approve secondary sales, but most restrict sales until an acquisition or IPO.
What happens to my options if the company is acquired? It depends on the deal. Vested options may be cashed out, converted into the buyer's options, or exercised, and unvested options may accelerate or convert.
Can I sell right after an IPO? Usually not. Most IPOs include a lockup period, often around 180 days, before employees can sell.
Is it better to exercise early? It can reduce taxes and start holding periods sooner, but you risk losing the money you invest if the company doesn't succeed.
Get a plan for your stock options
Have stock options and not sure when to exercise, how much tax you'll owe, or how much company stock to keep? Reliant Wealth Advisory helps tech professionals build a clear plan for their equity compensation.
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About the author
Michael Walstedt, CFA, CFP®, is the founder of Reliant Wealth Advisory, a fee-only fiduciary firm in Hoboken, New Jersey. He helps tech professionals in the New York/New Jersey area, as well as nationwide, plan around stock options, RSUs, and concentrated stock positions.
This article is for educational purposes only and is not tax, legal, or investment advice. Tax rules change, and your situation may differ. Consult a qualified tax professional before acting.
