How are RSUs taxed when they vest?

When RSUs vest, the fair market value of the shares is treated as ordinary income on your W-2. Your employer withholds federal income tax, state income tax, Social Security, and Medicare taxes — typically by selling some of the vesting shares automatically (sell-to-cover). Any gain or loss after the vest date is a capital gain or loss, taxed at the short-term or long-term rate depending on how long you hold the shares after vesting.

What is the alternative minimum tax (AMT) and how does it affect ISOs?

The alternative minimum tax (AMT) is a parallel tax calculation that adds back certain deductions and income. For incentive stock options (ISOs), the spread between the stock price and your strike price at exercise is added to your AMT income — even though it's not taxed under the regular tax system. If the AMT calculation results in a higher tax than your regular tax, you pay the difference. This can create large unexpected tax bills when exercising ISOs with a significant spread. The AMT paid may generate an AMT credit that offsets future regular tax in later years.

What is the difference between a qualifying and disqualifying ESPP disposition?

A qualifying disposition means you held ESPP shares for at least 2 years from the offering date and 1 year from the purchase date. The ordinary income portion is limited to the lesser of the actual gain or the discount based on the offering-date price. Any remaining gain is taxed at the long-term capital gains rate. A disqualifying disposition (selling before those periods) treats the entire purchase discount as ordinary income, regardless of the stock price movement.

Equity Compensation Taxes — VaporCalc Learn

The value of equity compensation depends heavily on what you keep after taxes. RSUs, stock options, and ESPPs each have different tax rules — and the choices you make about when to exercise or sell can change your tax bill by thousands of dollars.

RSU Taxes: Ordinary Income at Vest

RSU taxation is relatively straightforward. When shares vest, the full fair market value counts as ordinary income — the same type of income as your salary. It shows up on your W-2 and is subject to all the usual taxes.

Taxes at vest

Federal income tax — At your marginal tax bracket (22%, 24%, 32%, or 35% for most tech employees).
State income tax — Varies by state. California charges up to 13.3%; Texas, Washington, and Florida charge 0%.
Social Security — 6.2% on income up to the wage base ($176,100 in 2026). If your salary already exceeds this, RSU income won't have additional Social Security tax.
Medicare — 1.45% on all income, plus an additional 0.9% surtax on income over $200,000 (single) or $250,000 (married).

Priya's tax surprise

Priya earns $180,000 base salary and has 500 RSU shares vest when the stock is $140. The $70,000 in RSU income pushes her total to $250,000 — crossing into the 35% federal bracket for part of it and triggering the 0.9% Medicare surtax on the amount over $200,000. Her effective combined tax rate on the RSU tranche is about 42% (federal + California state + FICA). Of the $70,000 gross, she keeps roughly $40,600.

After-vest holding: capital gains rules

Once shares vest, your cost basis is the fair market value at vest — the amount already taxed as income. If you hold the shares and they go up, that additional gain is a capital gain. Hold for more than 1 year for the long-term capital gains rate (0%, 15%, or 20%). Sell within 1 year and it's a short-term capital gain, taxed at ordinary income rates.

Myth: Selling at vest means paying more tax

You owe the same tax whether you sell at vest or hold. The ordinary income tax is triggered by vesting, not selling. Selling immediately after vest typically generates no additional capital gain (since the price hasn't changed). Holding means taking on stock-price risk for a potential future capital gain — which may or may not materialize.

Try it

Use the RSU Calculator to see the combined federal, state, and FICA tax impact on each vesting tranche.

Stock Option Taxes: ISO vs NSO

The two option types have fundamentally different tax treatment. Understanding the difference can save you tens of thousands of dollars.

NSO tax treatment

Non-qualified stock options are the simpler case. When you exercise (buy shares at the strike price), the spread — the difference between market price and strike price — is immediately taxed as ordinary income. It appears on your W-2, and your employer withholds federal income tax, state tax, Social Security, and Medicare. After exercise, any further gain or loss is a capital gain/loss based on how long you hold.

ISO tax treatment

Incentive stock options have no regular income tax at exercise. The spread is not included in your W-2 income. However, the spread is added to your alternative minimum tax (AMT) income. If the AMT calculation results in a higher tax than your regular tax, you pay the difference as AMT.

The AMT trade-off: you avoid ordinary income rates at exercise, but you might owe AMT. The AMT you pay creates a credit you can use in future years when your regular tax exceeds AMT — but recovering the credit can take years.

ISO qualifying disposition

To get the best tax treatment on ISOs, you must hold the shares for at least:

1 year after the exercise date, AND
2 years after the grant date

If you meet both conditions, the entire gain (sale price minus strike price) is taxed at the long-term capital gains rate — potentially 15% instead of 37%. Selling before meeting both conditions is a "disqualifying disposition" and the spread reverts to ordinary income.

Two strategies for the same options

Alex has 5,000 ISOs with a $20 strike price. The stock is $80. The spread is $300,000.

Strategy A: Exercise and sell immediately. The $300,000 spread is taxed as ordinary income (disqualifying disposition). At a 40% combined rate, Alex pays $120,000 in taxes and nets $180,000.

Strategy B: Exercise and hold for 1+ year. Alex pays the $100,000 exercise cost out of pocket. The $300,000 spread triggers an AMT review. If Alex owes $50,000 in AMT this year, that becomes a credit for future years. After holding 1+ year, Alex sells at $80 and pays 15% long-term capital gains ($45,000) on the $300,000 gain. Net tax: $45,000 + temporary AMT of $50,000 (mostly recoverable) vs $120,000 in Strategy A. But Alex needed $100,000 in cash upfront and took stock-price risk for a year.

Try it

Model both scenarios in the Stock Options Calculator. Toggle between ISO and NSO to see the tax difference, and adjust the holding period to compare qualifying vs disqualifying outcomes.

ESPP Taxes: Qualifying vs Disqualifying

ESPP taxation depends on how long you hold the shares after purchase.

Disqualifying disposition (sell immediately)

If you sell ESPP shares before holding them for 2 years from the offering date and 1 year from the purchase date, the entire discount (market price minus your purchase price) is taxed as ordinary income on your W-2. This is the simpler and more common approach — many employees sell immediately to lock in the guaranteed discount and avoid stock-price risk.

Qualifying disposition (hold for tax benefit)

If you meet both holding periods, the ordinary income portion is limited to the lesser of:

The actual gain (sale price minus your purchase price), or
The discount percentage applied to the offering-date price (typically 15% × offering price)

Any gain beyond the ordinary income portion is taxed at the long-term capital gains rate. The tax savings can be significant — but you're holding company stock for 1–2 years, which adds concentration risk.

Sell now or hold?

Morgan bought $7,500 worth of ESPP shares at $85 (15% off the $100 offering price). The shares are worth $10,000 at purchase. Selling immediately: the $2,500 discount is ordinary income, taxed at ~35% combined = $875 tax, net $1,625 gain. Holding for a qualifying disposition: if the stock is still $120 at sale, the ordinary income portion is capped at $1,500 (15% × $100), and the remaining $1,000 of gain is taxed at 15% LTCG = $150. Total tax: $525 + $150 = $675, saving $200. But Morgan held company stock for a year, risking a price drop.

Try it

Compare both scenarios in the ESPP Calculator to see the tax difference between selling immediately and holding for a qualifying disposition.

Strategies to Reduce Your Equity Tax Bill

Batch ISO exercises across tax years

Exercising a large ISO grant in one year can trigger significant AMT. Spreading exercises across 2–3 tax years keeps each year's AMT income lower, potentially staying under the AMT exemption threshold entirely.

Maximize pre-tax deductions in high-vest years

In a year when a large RSU tranche vests, you're pushed into a higher bracket. Maximize 401(k) contributions ($23,500 in 2026), HSA contributions ($4,300 single / $8,550 family), and any other pre-tax deductions to reduce taxable income.

Tax-loss harvesting against equity gains

If you have capital losses elsewhere in your portfolio, they can offset capital gains from selling vested shares. This doesn't help with the ordinary income portion (RSUs at vest, NSO spread), but it reduces the tax on any appreciation after vest/exercise.

🤔

Look at your equity compensation schedule for the next 2–3 years. Are there years with unusually large vesting events? What pre-tax deductions could you maximize in those years to lower the tax impact?

Key takeaways

RSUs are taxed as ordinary income when they vest. Selling at vest doesn't increase your tax — it's already owed.
NSO options: the spread is ordinary income at exercise, plus FICA taxes.
ISO options: no regular tax at exercise, but watch for AMT. Qualifying dispositions (hold 1yr + 2yr) get long-term capital gains rates.
ESPP qualifying dispositions limit the ordinary income portion and may save money — but require holding company stock longer.
Batching exercises, maximizing pre-tax deductions, and tax-loss harvesting can all reduce your equity tax bill.