Equity compensation sounds simple until you actually get some. Then you're staring at a vesting schedule, a grant letter full of unfamiliar terms, and a tax bill that doesn't look anything like your regular paycheck withholding. Restricted Stock Units (RSUs), Incentive Stock Options (ISOs), and Non-Qualified Stock Options (NQSOs) are the three most common forms, and each one is taxed on a completely different timeline.
Restricted Stock Units (RSUs)
RSUs are the most straightforward of the three. You don't buy anything. Your employer simply grants you shares that vest over time. The moment they vest, the full value is treated as ordinary income, and it shows up on your W-2 just like your salary. Your employer typically withholds shares (or cash) to cover taxes, but that withholding is often calculated at a flat supplemental rate that doesn't match your actual tax bracket, which is why a lot of high earners end up owing more at filing time.
The decision point with RSUs usually isn't "should I exercise." There's nothing to exercise. It's whether to hold the shares after they vest or sell right away. Holding concentrates more of your net worth in a single company stock, which carries its own risk.
Incentive Stock Options (ISOs)
ISOs work differently. You're granted the right to buy shares at a fixed "strike price," and if the stock has appreciated, that can be valuable. But ISOs aren't taxed at vesting. They're taxed when you exercise and eventually sell, and the rules in between are where things get complicated.
Exercising ISOs doesn't trigger ordinary income tax, but it can trigger the Alternative Minimum Tax (AMT) if the spread between your strike price and the current fair market value is large. Whether you owe AMT, and how much, depends on your full tax picture for the year, not just the option exercise in isolation. Hold the shares long enough after exercising (generally more than a year from exercise and two years from grant) and any gain when you sell can qualify for long-term capital gains treatment instead of ordinary income rates.
Non-Qualified Stock Options (NQSOs)
NQSOs are taxed more simply than ISOs, but less favorably. When you exercise, the spread between the strike price and the fair market value is taxed immediately as ordinary income, subject to withholding, regardless of whether you sell the shares. There's no AMT wrinkle here, but there's also no way to defer that ordinary income tax hit by simply holding.
Why the Difference Matters
These aren't just technical distinctions. The type of equity you hold changes when a tax bill shows up, how large it can be, and what levers you have to manage it: timing an exercise across tax years, coordinating with other income, or deciding how much company stock is too much relative to the rest of your portfolio. Treating every vesting or exercise event the same way, regardless of which type of equity is involved, is one of the more expensive mistakes we see.
If you're navigating a grant for the first time, or you've been sitting on unexercised options without a clear plan, it's worth walking through your specific numbers before your next vesting date or year-end deadline.
This article is for general educational purposes only and does not constitute personalized investment, tax, or legal advice. Every situation is different. Talk with a qualified professional about your specific circumstances before acting on anything here.