How equity compensation is taxed

Four instruments, four completely different answers. What decides your tax is not how much your equity is worth but which of the four you hold, and at which of the four possible moments the tax code decides to notice it.

Guide Last verified 2026-07-27 How we verify

In short

There are four moments the code could tax you — grant, vest, exercise, sale — and each instrument picks a different subset of them.
RSUs are the simplest and the least favourable: full value taxed as wages at vest, with no choice in the matter.
Non-qualified options tax the spread at exercise as wages, with Social Security and Medicare. You choose when, which is the whole advantage.
Incentive stock options are invisible to regular income tax at exercise but visible to the alternative minimum tax, and can convert everything to long-term capital gain if you satisfy two holding periods.
ESPP shares are taxed on a discount measured against the *grant*-date price, which is why a qualifying disposition can produce more ordinary income than people expect.

Ask what tax you will pay on your equity and the honest first answer is a question: which kind do you have? The four common instruments are taxed under different sections of the code, at different moments, at different rates, and with different amounts of choice available to you. Two people at the same company with grants of identical value can end up tens of thousands of dollars apart.

This is the map rather than the arithmetic. Each instrument has a calculator on this site that works the numbers; what follows is the structure they all sit inside, and the handful of distinctions that account for most of the difference in outcomes.

Run your own numbers: ISO AMT Calculator.

The four moments

Every equity instrument passes through some subset of the same four events, and the design question the code answers each time is which of them is the taxable one.

Grant — you are given the award. Almost never taxable, because you have received a promise rather than property.
Vest — you satisfy the service condition. Taxable for RSUs and restricted stock; irrelevant for options, which only become exercisable.
Exercise — you pay the strike and receive shares. Taxable for non-qualified options; an alternative minimum tax event only for incentive stock options.
Sale — you dispose of the shares. Capital gain or loss on everything above your basis, plus, for statutory options sold too early, a retroactive helping of ordinary income.

Almost every surprise in this area comes from a mismatch between when tax is due and when cash arrives. The worst cases are all the same shape: taxed at one of the middle moments, unable to sell until the last one.

Restricted stock units

The full market value of the shares becomes ordinary income on the vesting date, exactly as though your employer had paid you that much in cash and you had immediately bought stock with it. There is no election, no timing choice and no preferential rate.

Because it is a wage payment, Social Security and Medicare apply and your employer must withhold. Withholding uses the statutory supplemental rate rather than your real one, which is the source of the most common single complaint in this whole area: a flat 22% is deducted while the actual marginal rate is 32% or 35%, and the gap is settled the following April.

The saving grace is that the basis in the shares becomes their value at vest, so if you sell immediately there is no further gain. Selling immediately is also the only way to avoid holding a concentrated position in your employer, which is a risk most people acquire without ever deciding to.

Non-qualified and incentive stock options

Both give you the right to buy at a fixed strike, and both are worth nothing at grant if that strike equals the current valuation — which is how they are almost always priced. Everything after that diverges.

A non-qualified option is taxed at exercise, on the spread between the strike and the value that day, as ordinary income with Social Security and Medicare. Your basis then steps up to the value at exercise, and any subsequent growth is capital gain. The choice of when to exercise is yours, and it is the only meaningful lever.

An incentive stock option is not taxed at exercise for regular income tax at all. Instead the spread is an adjustment for the alternative minimum tax under §56(b)(3), which can produce a large bill in a year with no cash to show for it. In exchange, holding the shares more than two years from grant and more than one year from exercise makes the entire gain long-term capital gain — a rate difference of roughly seventeen points at high incomes.

Sell before those two periods are up and the arrangement is disqualified: the exercise discount becomes ordinary compensation retroactively. It still escapes Social Security and Medicare, because §3121(a)(22) excludes dispositions of statutory option stock from wages, which is the one consolation.

Employee stock purchase plans

A §423 plan lets you buy company stock at a discount, commonly 15%, usually with a lookback that applies the discount to the lower of the price at the start of the offering period and the price on the purchase date. The combination can produce a substantially larger effective discount than 15%.

Nothing is taxed at purchase. At sale the treatment depends on whether you held the shares more than two years from the offering date and more than one year from the purchase date.

The counter-intuitive part is what happens if you did. On a qualifying disposition the ordinary income component is the lesser of your actual gain and the discount measured against the grant-date price — not the purchase price. In a period where the stock rose sharply, that grant-date measurement can produce more ordinary income than the disqualifying treatment would have, which means waiting occasionally costs money.

What actually decides the outcome

Reduced to the essentials, three things account for most of the spread between good and bad outcomes on identical grants.

Whether ordinary rates or capital rates apply. The gap is around seventeen percentage points federal at high incomes, before state tax. Every favourable structure in this area is a mechanism for converting one into the other.
Whether the tax arrives before the cash. Alternative minimum tax on an exercise, or ordinary income on a private RSU settlement, both land while the shares are unsellable. This is what turns a paper gain into a real loss when the price falls afterwards.
Whether you have a choice of year. Options give you one and RSUs do not. Splitting an exercise across two calendar years is one of the few genuinely effective moves available to an ordinary employee.

None of this is a recommendation about your own grant. The rules above are general and the interactions — with your other income, your state, and the rest of your return — are not. Each instrument has a calculator on this site that prices the specific case.

Questions

Which is better, ISOs or NSOs?

Incentive stock options are better on paper and only if you can afford to use them properly. Their advantage requires exercising and then holding for over a year while paying alternative minimum tax on a gain you have not realised — which needs cash, and exposes you to the company failing in the meantime.

Exercised and sold on the same day, the two are nearly identical: both produce ordinary income on the whole spread. The only difference is Social Security and Medicare, which the ISO escapes.

Why do RSUs feel so much worse than options?

Because they are simpler and less favourable, and because you have no control. Full value at vest, ordinary rates, no timing choice, no preferential treatment available under any circumstances.

They are also far less risky, which is the trade. An RSU is worth something as long as the share price is above zero; an option struck at today’s valuation is worth nothing unless the company grows. Companies switch from options to RSUs as they mature precisely because the risk profile stops matching what employees want.

Is the tax different at a private company?

The rules are identical. What differs is that you cannot sell anything, which turns several of them from inconveniences into real problems — most obviously alternative minimum tax on an ISO exercise, where you owe cash on a gain that has no market.

Private companies also commonly use double-trigger RSUs, which defer tax until a liquidity event and then concentrate several years of income into a single tax year.

Does my state tax it the same way?

Mostly, but not always, and the exceptions are expensive. Most states follow the federal characterisation and tax capital gains at ordinary rates, so the federal preference for long-term gain simply does not exist at state level.

A few states diverge more sharply. California has its own alternative minimum tax and does not recognise the qualified small business stock exclusion at all. Where you live when the income is recognised — and sometimes where you lived when you earned it — can matter as much as the instrument.

When does the holding period actually start?

For shares from an option, on the exercise date — not the grant date, and not the vesting date. For RSUs, on the settlement date when shares are delivered. For ESPP shares, on the purchase date, though the qualifying-disposition test also reaches back to the offering date.

Restricted stock with an 83(b) election is the exception worth knowing: the election starts the clock at grant rather than at each vesting date, which on a four-year vest can be the difference between qualifying for long-term treatment and missing it entirely.

Can I choose to be taxed earlier?

For restricted stock, yes, and it is often the right call: an 83(b) election taxes you now on today’s value instead of at each vest on a rising one. There is a strict thirty-day deadline and no relief for missing it.

For RSUs, generally no — an 83(b) election is not available for units, because nothing has been transferred. The narrow §83(i) deferral runs the other way and is available only at companies granting equity to at least 80% of their US employees.

Is anything I enter on this site sent anywhere?

No. Every calculator here runs entirely in your browser with no network request, nothing is stored between visits, and there is no account or email gate on any result.

Sources

Everything asserted above traces to one of these. We cite the statute, the regulation, or the IRS directly — never another commentary site.

This guide is educational information, not tax, legal or investment advice, and reading it creates no professional relationship. Equity compensation interacts with the rest of your return in ways a single article cannot see. Before acting on anything here, take it to a qualified tax adviser.