Stock options can be a valuable part of your compensation, but exercising them comes with important financial and tax considerations. While Texas has no state income tax, federal tax rules still apply, and understanding the process can help you make informed decisions about your equity. Whether you have Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs), knowing when and how to exercise can impact your financial outcome.

1. How Stock Option Taxation Works in Texas

Texas stands out as one of the few states that does not impose a state income tax. This makes it one of the most favorable states for exercising stock options, as employees only need to consider federal tax implications when making their decision.

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 Alternative Minimum Tax or AMT, a parallel tax system that can result in a hefty bill.
• Texas does not have its own AMT, meaning you only need to consider federal AMT rates of 26% or 28% when calculating potential taxes. You can estimate your federal AMT impact using our AMT calculator.

NSOs and Ordinary Income Tax

• NSOs are subject to federal ordinary income tax at the time of exercise, but no additional Texas state tax applies.
• The taxable amount is the difference between the strike price and the FMV at exercise.
• Since Texas has no state withholding requirements, only federal taxes will be withheld by your employer at the time of exercise.

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

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 allow NSO extensions).
• 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 Texas

While Texas has no state tax burden, the cost of exercising can still be significant due to federal taxes and the AMT. Here are some ways to manage the financial impact:

• Cash Exercise – Paying the full cost out-of-pocket, including the strike price and federal 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, often at a lower price than the potential future value.
• 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 financial 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).
• Long-Term Capital Gains (sold >1 year from exercise & 2 years from grant for ISOs) – Taxed at a lower rate (20% federal).

For a comprehensive guide on how capital gains taxes work, including the differences between short-term and long-term gains, you can refer to this TurboTax guide.

As a resident of Texas, you benefit from no state income tax, which means you won't owe state capital gains tax on your stock option exercises or sales. All your capital gains and other income from equity compensation will be subject only to federal taxes (such as federal income tax and Alternative Minimum Tax, if applicable).

If your company IPOs, you may be subject to a lock-up period before selling. In some cases, secondary sales or tender offers can provide pre-IPO liquidity.

5. Final Thoughts

Exercising stock options in Texas offers a tax advantage over high-tax states like California or New York, thanks to no state income tax. However, federal tax implications, including AMT for ISOs, still apply. If you’re considering exercising but are unsure about the costs 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. Learn more about our process or fill out the form below to explore your options.

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

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Written by Jordan Long, Marketing Lead at ESO Fund