# Employee stock options: ISOs, NSOs and RSUs

> ISOs, NSOs and RSUs: how each is taxed, Northwind's first grants to Priya Shah and Marcus Lee, and the expense they put on the P&L.

Source: https://lopifi.com/learn/employee-stock-options-iso-vs-nso
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

---

**What is the difference between ISOs and NSOs, and how do startup stock options work?** ISOs, NSOs and RSUs: how each is taxed, Northwind's first grants to Priya Shah and Marcus Lee, and the expense they put on the P&L.

On October 1, 2026 Northwind's board reserves an [option pool](https://lopifi.com/md/glossary/option-pool) of 1,000,000 shares under an equity incentive plan the stockholders approve. On December 1, 2026 it grants 40,000 options to Priya Shah, its operations manager, and 25,000 to Marcus Lee, its warehouse associate — [incentive stock options](https://lopifi.com/md/glossary/incentive-stock-option) at an [exercise price](https://lopifi.com/md/glossary/exercise-price) of $0.06, the [409A value](https://lopifi.com/md/glossary/409a-valuation), vesting over four years with a one-year cliff.

> **An option is the right to buy a share at a fixed price later. Its value to the employee is the gap between that price and what the share becomes worth.**

|  | At grant | At vesting / exercise | At sale |
| --- | --- | --- | --- |
| ISO | Nothing | No regular tax at exercise; the spread can trigger AMT | Capital gain if held 2 years from grant and 1 from exercise |
| NSO | Nothing (no readily determinable value) | Spread is ordinary income at exercise | Further gain is capital |
| RSU | Nothing | Value of the shares delivered is income | Further gain is capital |
| Restricted stock + 83(b) | Value less price paid — zero at a founder's price | Nothing | Gain is capital |

When each award is taxed. ISOs and NSOs from IRS Topic 427 and Pub. 525; RSUs and restricted stock under §83.

> “the option price is not less than the fair market value of the stock at the time such option is granted”

— [26 U.S.C. §422(b)(4)](https://www.law.cornell.edu/uscode/text/26/422), Incentive stock options: priced at fair market value, ten-year term, employees only

> “you generally don't include any amount in your gross income when you receive or exercise the option”

— [IRS Topic No. 427, Stock options](https://www.irs.gov/taxtopics/tc427), ISOs at grant and exercise, NSOs at exercise, and the AMT

*[Figure: vesting]*

Priya Shah's 40,000 options: 10,000 at the cliff on December 1, 2027, then monthly.

**Northwind — The grants on the P&L.** The grants are pay, so they are an expense. At an assumed grant-date fair value of $0.03 an option — an option-pricing model's output, not the strike — 65,000 options are $1,950 of [stock-based compensation](https://lopifi.com/md/glossary/stock-based-compensation), $40.62 a month over 48 months. Small, because the company is young; skipped, it is the first thing diligence rebuilds.

> **Form 3921.** A company whose employee exercises an ISO must send that employee Form 3921 — for 2025 exercises, by January 31, 2026, per IRS Publication 525.

> “The corporation must send or provide you with the form by January 31, 2026.”

— [IRS Pub. 525 (2025), Statutory Stock Options — Form 3921](https://www.irs.gov/publications/p525), Form 3921 to every employee who exercised an ISO in 2025

In this lesson: the 409A valuation and the strike price, the $100,000 ISO limit and early exercise, the 90-day exercise window, and RSUs.

## Pages in this lesson

- [The 409A valuation and the strike price](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/409a-valuation-and-strike-price) — 5 min. What is a 409A valuation and why does it set the strike price?
- [The $100,000 ISO limit and early exercise](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/iso-100000-limit-and-early-exercise) — 6 min. What is the $100,000 ISO limit, and how does early exercise affect it?
- [The 90-day exercise window](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/post-termination-exercise-window) — 3 min. What happens to stock options when an employee leaves?
- [RSUs](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/rsus-at-later-stage) — 3 min. What is an RSU, and when do companies switch from options to RSUs?

## Where this lesson's rules come from

- [26 U.S.C. §422(b)(4)](https://www.law.cornell.edu/uscode/text/26/422) — Incentive stock options: priced at fair market value, ten-year term, employees only (statute)
- [IRS Topic No. 427, Stock options](https://www.irs.gov/taxtopics/tc427) — ISOs at grant and exercise, NSOs at exercise, and the AMT (irs)
- [IRS Pub. 525 (2025), Statutory Stock Options — Form 3921](https://www.irs.gov/publications/p525) — Form 3921 to every employee who exercised an ISO in 2025 (irs)
- [ASC 718 — Compensation—Stock Compensation](https://asc.fasb.org/718/tableOfContent) — Equity awards are an expense, measured at grant-date fair value — and move no cash (codification)
- [Wikipedia, “Incentive stock option”](https://en.wikipedia.org/wiki/Incentive_stock_option) — Incentive stock options — background (reference)

## Read further

- https://lopifi.com/md/journal-entries/stock-based-compensation
- https://lopifi.com/md/startups/stock-options-409a-and-vesting
- https://lopifi.com/md/accounting/409a-valuation
- https://lopifi.com/md/accounting/option-pool
- https://lopifi.com/md/accounting/asc-718

- **Track:** [Cap tables & raising](https://lopifi.com/md/learn/equity)
- **Lesson:** Lesson 6 of 10 — 10 min
- **Terms taught:** [Incentive stock option](https://lopifi.com/md/glossary/incentive-stock-option), [Nonstatutory stock option](https://lopifi.com/md/glossary/nonstatutory-stock-option), [Exercise price](https://lopifi.com/md/glossary/exercise-price), [Option pool](https://lopifi.com/md/glossary/option-pool), [409A valuation](https://lopifi.com/md/glossary/409a-valuation), [Stock-based compensation](https://lopifi.com/md/glossary/stock-based-compensation)
- **Previous:** [Protective provisions, Cap table · Lesson 5](https://lopifi.com/md/learn/term-sheet-explained/protective-provisions)
- **Next:** [The 409A valuation and the strike price](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/409a-valuation-and-strike-price)
- **The course:** https://lopifi.com/md/learn