How Are Stock Options Taxed?
Quick Answer
Stock options and RSUs are taxed differently depending on the type. RSUs are taxed as ordinary income when they vest. NSOs are taxed as ordinary income when exercised. ISOs receive preferential treatment — no tax at exercise (for regular tax purposes), with potential long-term capital gains treatment if holding requirements are met. All three can add significantly to your tax bill in the year they trigger.
The Three Common Types
RSUs (Restricted Stock Units)
The most common equity compensation at large companies.
| Event | Tax Treatment |
|---|---|
| Grant date | No tax |
| Vesting date | Taxed as ordinary income (full value) |
| Sale (after vesting) | Capital gains tax on appreciation |
NSOs (Non-Qualified Stock Options)
Common at both startups and public companies.
| Event | Tax Treatment |
|---|---|
| Grant date | No tax |
| Exercise | Ordinary income on the "spread" (FMV minus exercise price) |
| Sale | Capital gains on appreciation after exercise |
ISOs (Incentive Stock Options)
Offered only to employees, with favorable tax treatment.
| Event | Tax Treatment |
|---|---|
| Grant date | No tax |
| Exercise | No regular income tax (but may trigger AMT) |
| Sale (if held 1yr after exercise + 2yrs after grant) | Long-term capital gains on total gain |
| Sale (disqualifying disposition) | Ordinary income on the spread |
Real Example: RSUs
Maria is a software engineer earning $130,000 in California. She receives 200 RSUs that vest over 4 years (50 shares per year). The stock price is $150 at vesting.
| Year 1 Vesting | Amount |
|---|---|
| Shares vesting | 50 |
| Stock price at vesting | $150 |
| Taxable income added | $7,500 |
| Federal tax withheld (22%) | $1,650 |
| California tax withheld (~9%) | $675 |
| Social Security (6.2%) | $465 |
| Medicare (1.45%) | $108.75 |
| Total withholding | $2,898.75 |
| Net value received | $4,601.25 |
Maria receives about 61% of the RSU value after taxes. The $7,500 is added to her W-2 income, pushing her total to $137,500 for the year. If the stock later rises to $200 and she sells, the $2,500 gain ($50 x 50 shares) is taxed as capital gains.
Use the SalaryHog calculator to estimate how RSU income increases your total tax burden.
Real Example: NSOs
Tom has NSOs with an exercise price of $20/share. The stock is now $80/share. He exercises 500 shares.
| Calculation | Amount |
|---|---|
| Exercise price | $20 x 500 = $10,000 |
| Fair market value | $80 x 500 = $40,000 |
| Taxable spread | $30,000 |
| Federal tax (24% bracket) | $7,200 |
| FICA (7.65%) | $2,295 |
| State tax (6%) | $1,800 |
| Total tax at exercise | $11,295 |
Tom pays $10,000 to exercise plus $11,295 in taxes. If the stock rises to $100 and he sells, the additional $10,000 gain ($20/share x 500) is taxed as capital gains.
How Stock Compensation Affects Your Tax Bracket
The most common surprise is bracket bump. If Maria's regular income of $130,000 puts her in the 24% bracket, vesting RSUs that add $30,000 could push her deeper into 24% or even into 32%.
Strategies to manage this:
- Increase 401(k) contributions in years when significant equity vests
- Maximize HSA contributions to reduce AGI
- Sell shares in lower-income years if possible
- Track your estimated tax obligations — the default 22% withholding on RSUs may not be enough for high earners
Stock Options as Part of Total Comp
When evaluating a job offer with equity:
- Ask about the vesting schedule (typically 4 years with a 1-year cliff)
- Understand the type (RSU vs ISO vs NSO) and tax implications
- Do not count unvested options at full face value in total compensation
- Remember that stock prices can decline — equity is not guaranteed income
See how your base salary compares at the SalaryHog calculator and factor equity into the total package.