Equity Compensation Tax: How RSUs, ISOs, ESPP, and AMT Actually Get Taxed

Restricted stock units are taxed as ordinary income when they vest, equal to the share price (fair market value) on the vesting date times the number of shares. That amount is added to your W-2 wages, and the same per-share value becomes your cost basis for the eventual sale.

When you later sell, you owe capital gains tax only on the change in value since vesting. If you sell immediately at the vesting price, there is little or no additional gain. Hold more than a year after vesting and the appreciation is long-term capital gain; sell within a year and it is short-term, taxed at ordinary rates.

Double-trigger RSUs at a private company vest only when both a time condition and a liquidity event (usually an IPO or acquisition) are met. The entire value hits as ordinary income at the liquidity event, which can be an enormous one-year spike that pushes you into the top bracket and triggers the 3.8% net investment income tax on related gains.

Incentive stock options create no regular income tax when you exercise them, but the bargain element (the fair market value at exercise minus the strike price) is a preference item for the Alternative Minimum Tax. You can owe AMT in the exercise year even though you received no cash and sold nothing.

Holding period drives the rest. A qualifying disposition (shares held more than two years from grant and more than one year from exercise) taxes the entire gain as long-term capital gain. A disqualifying disposition (selling sooner) turns the bargain element into ordinary compensation income, with any remaining gain as capital gain.

AMT paid on an ISO exercise is not lost. It generates a minimum tax credit you recover in later years when your regular tax exceeds your tentative AMT. Note also the $100,000 limit: the value of ISOs first becoming exercisable in a single year (measured at grant-date price) above $100,000 is treated as NQSOs.

Non-qualified stock options are taxed as ordinary income at exercise, equal to the spread between the fair market value and your strike price. That spread is treated as W-2 wages subject to income and payroll tax withholding, and it becomes part of your cost basis in the shares.

When you later sell, you have a capital gain or loss measured from the fair market value at exercise, with the holding period starting on the exercise date. Unlike an ISO, an NQSO never creates an AMT preference, because the spread is already taxed as ordinary income up front.

The same basis trap as RSUs applies: the broker often reports only the strike price you paid, not the higher amount that already passed through your W-2. Adjust the basis on Form 8949 so the spread is not taxed a second time.

A qualified Section 423 employee stock purchase plan is not taxed when you buy the shares; tax is triggered when you sell. The discount (up to 15%) is taxed as ordinary income and the rest is capital gain, but the split depends on whether the sale is a qualifying or disqualifying disposition.

In a qualifying disposition (held more than two years from the offering date and more than one year from purchase), the ordinary income is limited to the lesser of the discount measured at the grant-date price or your actual gain, and the remainder is long-term capital gain. In a disqualifying disposition, the ordinary income equals the fair market value at purchase minus the purchase price, with any remaining gain capital in character.

Plans with a lookback feature set the purchase price using the lower of the price at the offering date or the purchase date, which makes the built-in discount larger. As with RSUs, watch the cost basis: it should include the ordinary income already recognized, or you will pay tax twice.

A Section 83(b) election lets you choose to be taxed on the value of restricted stock or early-exercised options at grant, instead of as the shares vest. Filed within 30 days of the grant or exercise, it converts future appreciation from ordinary income into long-term capital gain and starts the capital-gains holding period immediately.

It is most valuable when the current value or spread is near zero, such as founder stock issued at formation or options exercised early at or close to the strike price. In that case you recognize little or no income now and shift all of the upside to capital gain rates.

The trade-off is real risk: if you leave before vesting and forfeit the shares, the tax you prepaid is not refundable, and you can owe tax on stock that later becomes worthless. The 30-day deadline is set by statute, has no extensions, and a late election is simply invalid.

Qualified Small Business Stock under Section 1202 can exclude a large portion, potentially all, of the gain on the sale of eligible C-corporation stock held long enough. To qualify, the stock must be original-issuance stock of a domestic C-corporation that was an active business with gross assets at or under the cap when the stock was issued.

For stock acquired on or before July 4, 2025, the rule is a more-than-five-year holding period for a 100% exclusion, capped at the greater of $10 million or 10 times your basis, with a $50 million gross-assets test. For stock acquired after July 4, 2025, the One Big Beautiful Bill Act phases the exclusion in at 50% after three years, 75% after four years, and 100% after five years, raises the per-issuer cap to $15 million, and raises the gross-assets test to $75 million.

Because the clock starts at issuance, founders who begin as an LLC often plan a timed conversion to a C-corporation to start the QSBS holding period. Advanced planning (gifting shares to stack exclusions, or a Section 1045 rollover into new QSBS) can multiply the benefit across family members or deals.

Equity compensation is generally sourced to the states where you worked between the grant date and the date the income is recognized (vesting for RSUs, exercise for options), not just where you live when you sell. Mobile employees frequently owe tax to more than one state on the same RSU or option income.

States apply a workday allocation: the share of the grant-to-vest (or grant-to-exercise) period spent working in a state determines how much of the income that state can tax. California in particular pursues trailing equity income from people who earned it there and later moved away.

A credit for taxes paid to another state usually prevents true double taxation, but only if you actually file in each state and claim it. Moving to a no-income-tax state like Texas before a large vest can be a legitimate planning lever, but the portion attributable to prior workdays elsewhere typically remains taxable to those states.