Guides / Equity compensation
Equity compensation: ISOs, NSOs, RSUs, and restricted stock.
Equity is taxed at different moments depending on what you hold, and the differences are not intuitive. Two employees at the same company, granted the same value on the same day, can face completely different bills depending on which instrument they were given and what they did in the first thirty days. Nearly every expensive mistake in this area is a timing mistake.
The instruments
Where the tax lands
Nonqualified stock options
No tax at grant. At exercise, the spread between the strike price and the fair market value is ordinary compensation income, reported on your W-2 and subject to withholding. Your basis in the shares becomes the value at exercise, and everything after that is capital gain or loss with the holding period starting at exercise.
Incentive stock options
No regular tax at grant or at exercise, but the spread at exercise is an adjustment for alternative minimum tax purposes, which is where large unexpected bills come from. If you hold the shares more than two years from grant and more than one year from exercise, the entire gain on sale is long-term capital gain. Sell earlier and you have a disqualifying disposition, taxed largely as ordinary income.
Restricted stock units
Taxed as ordinary income on the fair market value at vesting, whether or not you sell. Most companies withhold by holding back shares, and they typically withhold at the flat supplemental wage rate, which is well below the top marginal rate. For a high earner that gap is the most common cause of a large April balance due.
Restricted stock and the 83(b) election
Actual shares subject to vesting are normally taxed as they vest, on the value at each vesting date. An election under section 83(b) instead includes the value at grant, which for a founder’s early shares is often near zero, and converts all subsequent appreciation into capital gain. It must be filed within thirty days of the transfer. There is no extension, no late relief, and no substitute.
Early exercise brings the same election into play
Where a plan allows exercising unvested options, the shares received are restricted stock and the same thirty-day election applies. This is a routine and valuable move at an early-stage company, and it is worth nothing if the filing window is missed.
What goes wrong
The recurring problems
Withholding is not the tax
Supplemental wage withholding on equity is a flat rate up to a threshold and a higher flat rate above it, and neither is your marginal rate. Someone whose income places them at the top bracket, and who also owes net investment income tax and state tax, will be underwithheld on every vest. The fix is estimated payments or additional withholding, planned during the year.
The alternative minimum tax on ISOs is a real cash cost
Exercising and holding incentive stock options can generate a tax bill on paper gains with no sale to fund it. If the shares then fall, the tax is still owed. Exercising in tranches, modeling the AMT threshold before exercising, and tracking the AMT credit generated in later years are all part of doing this properly.
Cost basis on the 1099-B is usually wrong
Broker reporting for shares acquired through equity compensation frequently omits the compensation income already included on your W-2, which makes the reported basis too low and the gain overstated. This produces both overpaid tax and, when the sale is omitted entirely, a CP2000. See CP2000 notices.
Qualified small business stock is worth checking
Stock in a qualifying C corporation held long enough can qualify for a substantial exclusion of gain under section 1202. The rules on holding period, per-issuer caps, and the corporation’s asset size were changed by 2025 legislation for newly issued stock, so which regime applies depends on when your shares were issued. It is worth establishing eligibility while the records still exist rather than at sale.
State allocation follows where you worked
New York allocates option income by workdays in the state between grant and vesting, so equity granted while you worked in New York remains partly New York income even if you exercise years later from Florida. See moving from New York to Florida.
This page is general information about how the rules work, not tax or legal advice for a specific situation. Facts change outcomes. Talk with the firm before acting on anything here.
Questions
Common questions
I have thirty days to file an 83(b). What if I miss it?
The election is gone. There is no late relief and no equivalent alternative, and the shares will be taxed as they vest on their value at each vesting date. Because the window is counted from the transfer date rather than from when you noticed, this is worth handling the same week the grant is signed.
Should I exercise my ISOs and hold?
Only after modeling the alternative minimum tax and confirming you can pay it without selling. Holding to reach long-term capital gain treatment is often worthwhile, and it carries a real cash cost and real risk if the shares fall. Exercising in tranches across years frequently manages both.
My RSUs vested and I did not sell. Do I owe tax?
Yes. RSUs are taxed on vesting regardless of whether you sell, and the shares withheld for taxes usually do not cover the full liability at higher income levels. Selling enough at vest to cover the actual tax is the simplest way to avoid an April problem.
Is it better to have ISOs or NSOs?
ISOs are more favorable if you can hold through both holding periods and absorb the alternative minimum tax. NSOs are simpler, more predictable, and produce a withholding credit at exercise. For most employees who exercise and sell at the same time, the difference is smaller than it appears.
My company was acquired. What happens to my equity?
It depends entirely on the deal terms: acceleration, assumption, cash-out, and escrow treatment all change the timing and character of the income. Acquisition years are worth modeling in advance, because the tax often lands in a single year at the top rate.
Before you exercise, not after.
The decisions that matter, when to exercise, how much, whether to elect, and what to sell, are all made before the event. Once the year closes the options are gone.