Case study: a large NSO exercise in one year
A director exercises $300k of spread at once, gets surprised by the bracket math, and learns the lever was the calendar all along.
NSOs · Case studies
How much can one click cost you? More than the tax on the gain, it turns out. This is a composite of a client I will call David, a director at a public company who exercised all his NSOs in a single year and ran straight into two surprises he never saw coming.
David had options on 10,000 shares, a $5 strike, and the stock sitting at $35. He had read that NSOs were the simple kind, no AMT, no holding-period maze, and he believed it. So one afternoon he exercised the whole grant in one go. The spread was $30 a share, $300,000 of ordinary income, all landing in that one tax year on top of a healthy salary.
Surprise one: the brackets stacked
David assumed the spread would be taxed at “his rate.” It was not. Piled on top of his salary, the $300,000 climbed through his brackets, and the last dollars of it were taxed at the top marginal rate, not the average rate he had in his head.
How the brackets stack in 2026
For 2026, the top marginal rate is 37% 2026, reached once taxable income passes $640,600 2026 single or $768,700 2026 married filing jointly. I am keeping David’s numbers in spread terms rather than a final tax figure, because where his last dollars land depends on his salary and filing status. The mechanism is what matters: a big block of ordinary income stacks on your salary and gets taxed at the rate that applies to your highest dollars, not your first ones.
Surprise two: the withholding fell short
David figured the tax was handled because his company withheld at exercise. It was not enough. NSO spreads are withheld at the flat supplemental wage rate, and for a high earner that flat rate sits well below the actual marginal rate the income gets taxed at.
The 2026 flat withholding rate
For 2026, the flat supplemental withholding rate is 22% 2026 (37% 2026 only on cumulative supplemental wages over $1,000,000 2026 in the year). The point stands either way: that flat rate is below the top marginal rate, so a six-figure spread in a high-income year leaves a real gap between what was withheld and what is owed. David found his gap the following April, in five figures, with a penalty for underpaying along the way.
What we would have done differently
Spread the exercise across years
Splitting the 10,000 shares across two or three tax years would have kept more of the spread in lower brackets instead of stacking it all at the top. Spreading NSO exercises across years is the single biggest lever here.
Use a low-income window if one was coming
David had no income gap on the horizon, but if a sabbatical or a job change had been near, exercising in that low year could have cut the bracket sharply.
Plan the cash for the true tax, not the withholding
Knowing the flat withholding would fall short, we would have set aside the difference and made a quarterly estimated payment to dodge the underpayment penalty.
Decide sell vs hold on purpose
After exercise, David held the shares with no plan. Whether to hold for the capital gains clock or sell to diversify should have been a deliberate call, not an accident.
The deeper lesson
NSOs really are the simple kind. No AMT, no two-year-from-grant rule, clear treatment. But simple does not mean free, and it does not mean timing-proof. The one lever NSOs hand you is the calendar, and David pulled it the worst possible way by compressing everything into a single year. The tax tail did not just wag the dog here; the dog never got asked.
What this means for you
If you are holding a big block of NSOs, the size of your tax bill is not fixed. How much spread you turn into income in any one year is the decision, and “all at once” is usually the most expensive answer. Map the exercise across years, fund the gap the flat withholding leaves, and choose sell-or-hold on purpose. A large exercise is exactly the moment to run the numbers with someone first, before the click you cannot take back.
More in NSOs
- How NSOs are taxed: the bargain element and everything after →
- How NSOs work: the complete guide →
- NSO exercise strategy: when to exercise, hold or sell, and the moves around it →
- NSO traps: the double-counted basis, the cash bills, and the deadlines that kill grants →
- Reporting NSOs: your W-2, your 1099-B, and the basis fix →
- State taxes on NSOs when you change states →
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