Start with the grant documents. “Options,” “restricted stock,” and “RSUs” are sometimes used casually in conversation, but the tax treatment depends on what was actually issued and when each event occurred.
This page provides general education, not individualized tax, legal, or investment advice. Tax rules and plan terms change, and state treatment may differ.
Non-qualified stock options (NSOs)
For a typical employee NSO exercised into vested shares, the difference between the strike price and the fair market value is generally compensation income. It is typically reported on Form W-2 and subject to income-tax withholding and payroll taxes.
The fair market value at exercise generally becomes the tax basis in the shares. A later sale then creates a capital gain or loss based on the change after exercise.
Plan for the cash needed: exercise can create taxable income before the shares have produced cash. With publicly traded stock, selling enough shares to cover the tax is often possible. Private-company shares may not have a buyer.
Incentive stock options (ISOs)
Exercising an ISO generally does not create ordinary income for regular federal income-tax purposes. The spread between fair market value and the strike price can, however, be an adjustment for the alternative minimum tax.
A sale more than one year after exercise and more than two years after grant may qualify for the favorable ISO holding-period treatment. Selling before both periods are met is a disqualifying disposition, and part of the result may be compensation income.
Exercising while the common-share value is low may reduce the spread that affects AMT, but it also commits cash to shares that may be difficult to sell or lose value. If the plan allows exercise before vesting, ask a tax professional about the additional rules before proceeding.
Restricted stock units (RSUs)
An RSU is a promise to deliver stock or cash after specified conditions are met. For standard RSUs, federal income tax generally arises at settlement, when the stock or cash is delivered. Settlement often coincides with vesting, but the dates can differ. Payroll-tax timing may differ too. The employer typically reports compensation on Form W-2 and withholds tax. See the RSU discussion in IRS Publication 5992.
Withholding may be less than the employee’s eventual tax rate. Check the projected return instead of assuming the shares withheld by the employer settle the full bill.
Restricted stock and the 83(b) election
Restricted stock is property transferred before it is fully vested. It is different from an RSU. An eligible recipient may choose an 83(b) election to recognize compensation based on the value at transfer minus the amount paid for the shares, rather than waiting for vesting.
The election must be filed with the IRS no later than 30 days after the property is transferred; see the IRS Form 15620 instructions. It can be costly if the shares fall in value or are forfeited. Standard RSUs generally are not eligible because no property has been transferred at grant. Confirm the award type, deadline, and filing requirements with a tax professional before acting.
Federal income-tax comparison
This table summarizes common employee awards. It assumes NSOs are exercised into vested shares and excludes special deferral arrangements. Payroll taxes can follow different timing rules.
| Event | NSO | ISO | RSU | Restricted stock with 83(b) election |
|---|---|---|---|---|
| Grant or issue | Usually no tax | Usually no tax | Usually no tax | Compensation on value at transfer minus amount paid |
| Vesting | Usually no tax | Usually no tax | Generally at settlement; may be the same date | Generally no additional compensation income |
| Exercise | Compensation income plus applicable withholding | Potential AMT adjustment | Not applicable | Not applicable |
| RSU settlement | Not applicable | Not applicable | Compensation when shares or cash are delivered | Not applicable |
| Sale | Capital gain or loss after exercise | Capital gain or a combination of capital gain and compensation income, depending on holding periods | Capital gain or loss after settlement | Capital gain or loss after transfer |
Consider the investment decision alongside the tax
Someone with company equity already depends on the employer for salary, benefits, and future grants. Holding a large amount of the same company’s stock adds the investment portfolio to that list.
Tax can influence when and how to diversify. Avoiding tax is not, by itself, a reason to leave an unacceptable portion of the family’s finances tied to one company.
Sources and review
Reviewed September 7, 2026. See IRS Topic 427: Stock options for the overview and Publication 525 for ISO holding periods and restricted-property rules. Check the linked IRS guidance and your grant documents with your tax professional before acting.