Guides · Equity compensation

Equity compensation — RSUs, options, ESPP explained

Equity compensation comes in many forms and each has its own tax treatment. RSUs are taxed as ordinary income when they vest. NQSOs are taxed at exercise on the bargain element, then as capital gains on subsequent appreciation. ISOs get preferential tax treatment if holding-period and employer-disqualifying-disposition rules are met. ESPPs offer a 15% discount but trigger ordinary income on the discount at sale. The TaxToNet calculator does not model equity — this guide covers what you'd face on top of the salary shown.

Why equity comp complicates the math

Salary is straightforward. Equity is not. Each form vests, exercises, or sells differently, and each event triggers its own tax. A $200,000 salary with $200,000 of RSU vesting is not the same tax situation as a $400,000 salary.

Specifically:

RSUs add to ordinary W-2 income at vest and are subject to federal income tax, Social Security, Medicare, and state tax (if applicable). They are not subject to FICA once the YMPE has been reached (the wage base for Social Security). Medicare has no cap.
NQSO exercise is a separate W-2 event for the bargain element. Subsequent sale is a separate capital gains event.
ISO exercise is not a regular W-2 event for AMT purposes — bargain element is an AMT preference item.
ESPP discount is ordinary compensation income at sale, calculated as the discount on the purchase price.

Restricted Stock Units (RSUs)

The simplest form. Your employer grants you a number of RSUs that vest on a future date. When they vest, the fair market value (FMV) of the shares at vest is added to your W-2 wages and taxed as ordinary income.

Worked example:

Grant: 1,000 RSUs vesting 4 years from grant date.
At vest: stock price $100/share.
Income recognized: $100,000 added to W-2 wages.
Federal withholding: typically 22% supplemental rate (often 37% if total income pushes you into the top bracket).
You now own the shares outright. Future appreciation is capital gain; future depreciation is capital loss.

The vest-date FMV becomes your cost basis. If the stock drops after vest, you still owe tax on the original $100,000 (assuming you did not sell to cover). This is the major downside of RSUs: tax without liquidity if you hold.

Companies often offer "sell-to-cover" at vest to withhold taxes via share sale, leaving you with the net shares net-of-tax. If your company doesn't, you owe the tax from other funds.

Non-qualified stock options (NQSOs)

NQSOs are options to buy company stock at a fixed strike price. They have two tax events:

Exercise — when you buy the shares at the strike. The "bargain element" (FMV at exercise − strike) is added to your W-2 wages and taxed as ordinary income.
Sale — when you sell the shares. The appreciation since exercise is taxed as capital gain (long or short term based on the holding period from exercise).

Worked example:

Grant: 1,000 NQSOs at strike $20, vesting 4 years.
At exercise (year 4): FMV $100/share.
Bargain element: ($100 − $20) × 1,000 = $80,000 added to W-2.
Your cost basis: $100,000 ($20 paid + $80,000 bargain element).
One year later, you sell at $150: $50,000 long-term capital gain.

Two things to note:

The $80,000 ordinary income at exercise is added to your top marginal rate. A high earner exercising 100,000 options in one year can easily push into the 37% bracket.
The capital gains holding period starts at exercise, not at grant. A 12-month hold after exercise qualifies for long-term treatment.

NQSOs typically require cash exercise (you pay the strike + withholding), unless the company offers a cashless exercise feature that converts the bargain element to share sale proceeds.

Incentive stock options (ISOs)

ISOs are tax-favored stock options with stricter rules. They trigger no regular tax at grant or exercise (just AMT implications). To get long-term capital gains treatment on the entire bargain element, you must:

Hold the shares for at least 2 years from the grant date.
Hold the shares for at least 1 year from the exercise date.

When both conditions are met ("qualifying disposition"):

Bargain element at exercise: long-term capital gain.
Appreciation since exercise: long-term capital gain.
No regular income tax (but AMT preference item at exercise may still apply).

When conditions are not met ("disqualifying disposition"):

Bargain element treated as ordinary income (added to W-2).
Cost basis stepped up to FMV at exercise.
Subsequent appreciation: capital gain (long or short based on holding period from exercise).

ISOs also have AMT implications: at exercise, the bargain element is an AMT preference item. If AMT exceeds regular tax at exercise, you owe the difference. The AMT credit can be recovered in future years when regular tax exceeds AMT.

ISOs are capped at $100,000 worth vesting per year. Excess amounts convert to NQSOs.

ESPP

Employee Stock Purchase Plans let you buy company stock at a discount, typically 15%, funded by payroll deductions over an offering period (6 or 12 months).

Two flavors:

Qualified ESPP — §423 plan. The discount can be up to 15%, and the plan can include a "lookback" feature where the purchase price is the lower of the stock price at the start or end of the offering period.
Non-qualified ESPP — discount is ordinary income at exercise; subsequent sale is capital gain.

Tax treatment of qualified ESPP depends on the holding period after purchase:

Disqualifying disposition — sale within 2 years of the offering start date or within 1 year of the purchase date. The discount is ordinary income; the remainder is capital gain.
Qualifying disposition — held both periods. The discount is ordinary income (but at the lower of grant-date or exercise-date price); the appreciation is long-term capital gain.

The "qualifying disposition" is more favorable for the participant because the bargain element is computed at the lower of two prices. A stock that ran up 50% during the offering period produces an even larger effective discount.

Side-by-side comparison

US equity compensation types — tax at a glance
Form	At grant	At vest/exercise	At sale
RSU	None	Ordinary income on FMV at vest	Capital gain on post-vest appreciation
NQSO	None	Ordinary income on bargain element at exercise	Capital gain on post-exercise appreciation
ISO (qualifying)	None	None for regular tax; AMT preference item at exercise	Long-term capital gain on full bargain element + appreciation
ISO (disqualifying)	None	Ordinary income on bargain element at exercise	Capital gain on post-exercise appreciation
ESPP (qualifying)	None	Ordinary income on discount at purchase	Long-term capital gain on appreciation since purchase
ESPP (disqualifying)	None	Ordinary income on discount at purchase	Short-term capital gain on post-purchase appreciation (held < 1 year)

Tax planning considerations

Concentrated stock position risk

Equity comp often leaves employees with significant concentrated positions in employer stock. The "diversification rule of thumb" is that no more than 5-10% of net worth should be in a single stock, including employer stock. Most employees ignore this and end up with 50%+ of net worth in their employer's shares.

A diversified sale plan (10b5-1 plan) lets you pre-schedule sales to spread the tax impact. Most public-company employers support these plans.

AMT for ISO exercises

ISO exercises trigger AMT calculations. Large ISO exercises in a single year can produce an AMT bill that's not visible on the regular tax return. Plan for it: hold cash aside before exercising.

Capital gains harvesting with vested shares

Once RSUs vest (and you sell to cover the withholding tax), you can sell additional shares to capture capital losses or realize long-term gains at the 0% bracket if your income is low enough.

Wash-sale rule

Selling vested shares at a loss and buying back within 30 days triggers the IRS wash-sale rule. The loss is disallowed; the disallowed loss is added to the basis of the replacement shares. Watch this in volatile employer stock.