Exercising Stock Options in California: A Guide for Employees

Stock options can be a valuable part of your compensation, but exercising them comes with important financial and tax considerations—especially in California, where state taxes add another layer of complexity. Whether you have Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs), understanding the process and potential tax implications can help you make informed decisions about your equity.

1. How Stock Option Taxation Works in California

In California, stock option taxation follows both federal and state rules. While federal tax treatment is the same across the U.S. (check out our Stock Option Taxes page), California has some of the highest state income tax rates, which can significantly impact your after-tax gains. California also has the highest AMT rate in the country (not shocking given most of the AMT action takes place in CA).

ISOs and the Alternative Minimum Tax (AMT)

• Exercising ISOs does not trigger ordinary income tax at the time of exercise.
• However, the difference between your strike price and the Fair Market Value (FMV) at exercise is subject to AMT, a parallel tax system that can result in a hefty bill.
• California has its own AMT system, separate from the federal one, which means you could owe AMT at both the federal and state levels. California’s AMT rates is 7% on top of the federal rate of 26% or 28%, making it important to calculate the full impact before exercising ISOs.

NSOs and Ordinary Income Tax

• NSOs are taxed at both federal and state ordinary income rates at the time of exercise.
• The taxable amount is the difference between the strike price and the FMV at exercise.
• This income is subject to California’s state income tax, which can be as high as 13.3%, in addition to federal taxes.
• NSO exercise taxes, both state and federal, should be withheld by your employer at the time of exercise.

2. When Should You Exercise Your Stock Options in California?

The best time to exercise depends on your financial situation, tax implications, and belief in your company’s future. Here are a few strategies:

Early Exercise

• Some companies allow early exercise, letting employees buy stock before it vests.
• This can be beneficial because it locks in a lower FMV, reducing potential tax liability.
• If you early exercise, filing an 83(b) election within 30 days is critical to avoid future tax complications.

Before an IPO or Liquidity Event

• If you anticipate your company going public or being acquired, exercising beforehand could allow you to start the capital gains holding period sooner.
• However, this comes with risk—if the company underperforms or delays liquidity, you may have spent cash on taxes for little return.

After Leaving Your Company (90-Day Window)

• ISOs must be exercised within 90 days of leaving your company, or they expire (some companies will allow an NSO extension).
• Many employees struggle with the high cost of exercising and paying associated taxes, leading them to either forfeit their options or seek funding solutions like ESO Fund.

3. Strategies to Cover the Cost of Exercising in California

Exercising stock options—especially in a high-tax state like California—can be expensive. Here are some ways to manage the financial burden:

• Cash Exercise – Paying the full cost out-of-pocket, including the strike price and taxes.
• Cashless Exercise – Selling shares immediately upon exercise to cover costs, but losing some upside potential. This is not always an option for private company employees, and in most cases the shares are bought back at FMV. This often reflects a low price to sell at.
• ESO Fund’s Risk-Free Option Exercise Funding – We cover 100% of the exercise cost (including taxes), allowing you to hold onto your shares and benefit from future gains without upfront risk.

4. What Happens After You Exercise?

Once you exercise, you officially own the shares. The next step is deciding when to sell, which determines how your gains are taxed:

• Short-Term Capital Gains (sold <1 year from exercise) – Taxed as ordinary income (up to 37% federal + 13.3% CA).
• Long-Term Capital Gains (sold >1 year from exercise & 2 years from grant for ISOs) – Taxed at a lower rate (20% federal + 13.3% CA).

If your company IPOs, you may be subject to a lock-up period before selling. Secondary sales or tender offers may provide pre-IPO liquidity in certain cases.

5. Final Thoughts

Exercising stock options in California requires careful planning due to high state taxes and AMT considerations. If you’re thinking about exercising but unsure about the costs, tax impact, or risks, exploring funding solutions like ESO Fund can help you retain your hard-earned equity without upfront financial strain.

Need Help Exercising?

We’ve helped thousands of startup employees navigate stock options without risking their personal cash. Get in touch with ESO Fund today using the form below to explore your options.

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Looking for another state? Check out our guides for New York and Texas.

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