Stock Options and RSUs: ISO, NSO and RSU Taxes

Equity pay is taxed differently depending on its type. Incentive stock options (ISOs), nonstatutory stock options (NSOs) and restricted stock units (RSUs) produce income at different times, and the paperwork from your employer and broker rarely tells the whole story. This guide explains each type, the alternative minimum tax (AMT) risk with ISOs, withholding and reporting.

How each type is taxed

Nonstatutory stock options (NSOs)

If an NSO has no readily determinable fair market value, which is the usual case, you have no income until you exercise. The amount to include is the difference between what you pay and the stock's fair market value when it becomes substantially vested. For an employee, that amount is wages. Your employer should include it in Boxes 1, 3 (up to the Social Security wage base) and 5, and show it in Box 12 with code V.

Your basis in the shares is what you paid plus the income you included. Your holding period starts when you exercise. A common error is relying on the broker's Form 1099-B, which for options granted since 2014 does not include the income you already reported. Adjust the basis on Form 8949 or you will pay tax twice on the same income.

Incentive stock options (ISOs)

ISOs get special treatment if they meet tax code rules. The plan needs shareholder approval, the option price must be at least the stock's value at grant, the term cannot exceed 10 years, and the option must be nontransferable. Only $100,000 of stock (valued at grant) can first become exercisable in a calendar year, and the excess is treated as an NSO. You must be an employee from grant until 3 months before you exercise. A 10% owner needs a 110% price and a 5-year term.

Regular tax. You report nothing at exercise. If you sell after both holding periods, which require waiting until the later of 1 year after exercise or 2 years after grant, all the gain is capital gain. If you sell earlier (a disqualifying disposition), you generally have ordinary income up to the spread at exercise, reported as wages, and the rest is capital gain. If you sell at a loss, it is a capital loss.

AMT. For the alternative minimum tax, the spread at exercise is an adjustment on Form 6251, line 2i, when the shares are transferable or no longer at risk of forfeiture. There is no adjustment if you sell in the same year. For tax year 2025, the AMT exemption is $88,100 for single filers and $137,000 for joint filers, phasing out above $626,350 and $1,252,700 of AMT income. For tax year 2026 the exemption is $90,100 and $140,200, phasing out above $500,000 and $1,000,000. AMT paid may produce a credit on Form 8801 in later years. See alternative minimum tax.

Reporting. The company sends Form 3921 by January 31 after the exercise year. Social Security and Medicare tax do not apply to an ISO exercise.

Example (hypothetical): You exercise ISOs for 10,000 shares at $2 when the stock is worth $12. The $100,000 spread is an AMT adjustment for that year. If you later sell at $15 after meeting both holding periods, you have $130,000 of long-term capital gain. If you sell six months after exercise at $15, you have $100,000 of ordinary income and $30,000 of short-term capital gain.

Restricted stock units (RSUs)

An RSU is a promise to deliver shares later. You have no income at grant. When the RSU vests and shares are delivered, the fair market value is wages, reported in Boxes 1, 3 and 5 of Form W-2. Your basis is that value, and your holding period for the shares starts then.

Many private-company RSUs vest only after both a service period and a liquidity event, such as an IPO, so the first tax bill can arrive when you cannot easily sell. A Section 83(i) election can defer tax for up to 5 years on qualified stock, but only under a broad-based plan with strict rules and a 30-day deadline.

Withholding and estimated taxes

Employers can withhold on supplemental wages at a flat 22%, or 37% on amounts over $1 million in a calendar year, under Publication 15 for 2026. Social Security, Medicare and the 0.9% Additional Medicare Tax on wages over $200,000 also apply. If your marginal federal rate is higher than 22%, withholding on the vest may leave a balance. Consider estimated taxes or extra withholding.

Example (hypothetical): 1,000 RSUs vest at $50 per share, so $50,000 of wages. Withholding at 22% is $11,000. If your top bracket is 32%, the federal tax is about $16,000, so you may owe roughly $5,000 more at filing.

Illinois and cross-border notes

Illinois taxes wages, including equity compensation, at a flat 4.95%. If a grant was earned partly while you worked abroad, the income may be taxed in more than one country, with foreign tax credits possible. See foreign tax credit for India income and H-1B and visa holders.

Common mistakes

• Exercising ISOs without modeling AMT, especially if the stock later falls
• Missing the basis adjustment on Form 8949
• Assuming withholding covers the tax
• Selling ISO shares early without realizing it changes the tax
• Exercising unvested shares without considering an 83(b) election

How we can help

We can model exercise and sale scenarios, estimate AMT, reconcile Forms W-2, 3921 and 1099-B, and plan payments. See equity planning and management, tax planning and Section 83(b) elections.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.