Equity compensation can be one of the fastest ways to grow your wealth, but without the right tax strategy, it can also lead to costly surprises.
This guide breaks down the four most common types of equity, RSUs, ISOs, NSOs, and ESPPs, into simple terms, real-life examples, and easy-to-read tables so you know exactly what to expect, when to expect it, and how to plan ahead to keep more in your pocket.
Quick Snapshot
| Equity Type | When you owe tax | What rate | What to watch |
|---|---|---|---|
| RSUs | At vesting (income), then at sale (capital gains) | Ordinary + payroll tax on the value; capital gains at sale | Default withholding is often too low; plan to cover the gap |
| NSOs | At exercise (income), then at sale (capital gains) | Ordinary + payroll tax on the spread; then capital gains | Large exercises can spike taxable income & push you into higher brackets |
| ISOs | No regular tax at exercise, but AMT may apply; tax at sale | All long-term capital gains if holding rules met; otherwise part ordinary | AMT can create a tax bill without cash from a sale, run models before exercising |
| ESPP | No tax at purchase; tax at sale | Part ordinary (usually up to discount), rest capital gains | Holding rules determine if most of your gain is taxed at lower long-term rates |
RSUs (Restricted Stock Units)
When you pay tax:
- At vesting: The market value of your shares is treated as ordinary income and subject to payroll taxes.
- At sale: If the price changes after vesting, the difference is taxed as capital gains.
Example:
You have 2,000 RSUs that vest on January 1 when the stock price is $25. $25 × 2,000 = $50,000 of ordinary income.
Your employer withholds about 22% for federal tax ($11,000), but if your actual tax rate is 35%, you may owe another $6,500 at tax time.
You keep the shares and sell a year later at $30. $30 − $25 = $5 gain per share × 2,000 = $10,000 long-term capital gains.
NSOs (Non-Qualified Stock Options)
When you pay tax:
- At exercise: You pay ordinary income tax and payroll taxes on the difference between the stock price at exercise and your strike price.
- At sale: Any increase in value after exercise is taxed as capital gains.
Example:
You have 5,000 NSOs with a strike price of $5. You exercise when the stock is trading at $15. $15 − $5 = $10 spread per share × 5,000 = $50,000 ordinary income.
This amount appears on your W-2.
Six months later, you sell at $18. $18 − $15 = $3 gain per share × 5,000 = $15,000 short-term capital gains.
ISOs (Incentive Stock Options)
When you pay tax:
- At exercise: No regular income tax, but the difference between the market value and strike price is counted for Alternative Minimum Tax (AMT) purposes.
- At sale: If you hold shares for at least 1 year after exercise and 2 years after grant, the gain is taxed entirely as long-term capital gains.
Example:
You have 10,000 ISOs with a strike price of $3. You exercise when the stock price is $10. $10 − $3 = $7 spread per share × 10,000 = $70,000 counted for AMT.
You haven’t sold, so you have no regular income tax yet, but you might owe AMT.
You sell more than 1 year after exercise and 2 years after grant at $14. $14 − $3 = $11 gain per share × 10,000 = $110,000 long-term capital gains.
If you had sold right after exercising, part of the $7 spread would have been taxed as ordinary income.
ESPP (Employee Stock Purchase Plan)
When you pay tax:
- At purchase: No tax is due, even if you buy at a discount.
- At sale: A portion (usually the discount) is taxed as ordinary income; the rest is capital gains. Better tax treatment applies if you hold for 2 years from the offering date and 1 year from purchase.
Example:
Your company offers a 15% discount and a lookback.
Offering date price: $20
Purchase date price: $28
You buy at $17 (15% off the lower $20). You purchase 1,000 shares at $17 = $17,000 total.
You sell at $30 after meeting the holding periods.
Ordinary income: lesser of (15% × $20 × 1,000 = $3,000) or the actual gain ($30 − $17 = $13 × 1,000 = $13,000). Result: $3,000 ordinary income.
Capital gains: $13,000 total gain − $3,000 ordinary = $10,000 long-term capital gains.
Taxes by Stage
| Stage | RSUs | NSOs | ISOs | ESPP |
|---|---|---|---|---|
| Grant | No tax when granted | No tax when granted | No tax when granted | No tax when granted |
| Vesting | You pay ordinary income tax and payroll taxes on the market value of the shares | Not applicable – NSOs don’t tax at vesting | Not applicable – ISOs don’t tax at vesting | Not applicable – ESPPs don’t tax at vesting |
| Exercise | Not applicable – RSUs don’t require exercise | You pay ordinary income tax and payroll taxes on the difference between the market price and strike price (the “spread”) | You pay no regular tax, but the “spread” is counted for AMT, which can create a tax bill even without a sale | Not applicable – ESPPs don’t require exercise |
| Sale & met holding rules | You pay capital gains tax on the increase in value since vesting | You pay capital gains tax on the increase in value since exercise | You pay all long-term capital gains tax on the difference between the strike price and sale price | You pay ordinary income tax on the discount portion, and long-term capital gains tax on the rest |
| Sale & did not meet holding rules | You pay capital gains tax (short-term if sold within 1 year of vesting) | You pay capital gains tax (short-term if sold within 1 year of exercise) | Part of the gain (the “spread” at exercise) is taxed as ordinary income, and the rest is capital gains | A larger portion of the gain is taxed as ordinary income, and the rest as capital gains |
Why Planning Ahead Saves You Money
The choices you make about when to exercise, hold, or sell your equity make a huge difference in your tax bill. Planning ahead helps you:
- Lower your tax rate by converting income that would be taxed at higher ordinary rates into income taxed at lower long-term capital gains rates.
- Avoid triggering AMT by knowing how much you can exercise without crossing the threshold.
- Prevent unexpected tax bills by making sure withholding and estimated payments match your real liability.
- Spread your income over multiple years to avoid stacking too much income in one year, which could push you into a higher tax bracket and increase your overall tax rate.
- Plan cash flow so you have the money to cover taxes without selling more stock than you want to.
- Minimize penalties and interest by making proactive estimated tax payments when needed.
- Leverage advanced tax strategies like real estate losses, Qualified Opportunity Zone deferrals, and capital loss harvesting to offset gains.
How We Can Help You Plan Ahead and Reduce Taxes
At TS CPA, we work with clients to create a clear, actionable equity tax plan tailored to your grants, goals, and timeline. Here is how we help:
- Model the tax impact before you exercise or sell so you know exactly what you will owe and when.
- Time transactions strategically to spread income across multiple tax years and lower your overall rate.
- Avoid under-withholding penalties and interest by calculating your true tax liability at each stage and adjusting withholding or estimated payments.
- Manage AMT exposure by running “what-if” scenarios and recovering AMT credits in future years.
- Coordinate your equity plan with your full financial picture, including retirement planning, charitable giving, and investment strategies.
- Advise on diversification strategies to reduce risk while keeping taxes in check.
Bottom line: Your equity can be one of your most valuable assets, but the tax rules are complex. With the right plan, you can keep more of your hard-earned gains and avoid costly surprises.