How RSUs are taxed
A restricted stock unit is a promise to deliver shares once you've met the vesting conditions, usually staying employed for a set time. When RSUs vest, the full market value of the shares is ordinary wage income that year. There's no purchase price and nothing to decide.
Your employer withholds tax at vest: usually a flat 22% federal (37% on supplemental wages above $1 million in a year), plus state tax and FICA. If the RSU income lands in the 32%, 35% or 37% federal bracket, the 22% doesn't cover it, and you owe the rest when you file. Example: at a $220,000 salary, a $60,000 vest is taxed federally at 32–35%. In California the combined marginal rate on that income, including state tax and Medicare, is roughly 45–48%, while about 36% was withheld.
How stock options work
Options give you the right to buy shares at a fixed price (the strike or exercise price) until they expire, usually 10 years after grant. The strike price is generally the stock's fair market value on the grant date. Options only have value if the stock rises above the strike price. There are two types.
Incentive stock options (ISOs)
ISOs are only available to employees. Their advantage: if you hold the shares for more than two years after the grant date and more than one year after exercise, the whole gain from strike price to sale price is taxed as a long-term capital gain (0%, 15% or 20%, plus possibly the 3.8% net investment income tax), not as ordinary income.
- No regular income tax at exercise and no withholding.
- AMT risk: the spread at exercise counts for the Alternative Minimum Tax if you still hold the shares at year-end. A large exercise can create an AMT bill even though you haven't sold anything.
- Disqualifying disposition: if you sell before meeting both holding periods, the spread at exercise (or your actual gain, if smaller) becomes ordinary income. It's reported on your W-2, but no tax is withheld on it, so the full tax is due when you file.
- Only $100,000 of ISOs (by grant-date value) can first become exercisable per year; any excess is treated as NSOs.
Non-qualified stock options (NSOs)
NSOs can be granted to employees, contractors, advisors and board members. When you exercise, the spread (market value minus strike price) is ordinary wage income for employees, subject to the same 22% supplemental withholding and FICA as RSUs. Later growth after exercise is a capital gain. There's no AMT issue and no special holding period.
Side-by-side comparison
| RSUs | ISOs | NSOs | |
|---|---|---|---|
| Cash needed | None | Strike price × shares, at exercise | Strike price × shares, at exercise |
| When taxed | At vest | At sale (AMT possible at exercise) | At exercise, then at sale |
| Tax on main gain | Ordinary income | Long-term capital gains if holding periods are met | Ordinary income on the spread |
| Withholding | Yes (22% federal + state + FICA) | None | Yes (22% federal + state + FICA) |
| Can be worthless? | Only if the stock goes to zero | Yes, if below the strike price | Yes, if below the strike price |
| Main risk | Withholding gap | AMT, cash to exercise, illiquid shares | Withholding gap, cash to exercise |
What the rate difference means: at the top federal bracket, ordinary income is taxed at 37%, while long-term capital gains are taxed at 20% plus the 3.8% net investment income tax, so 23.8%. On a $500,000 gain, that's about $66,000 less federal tax if ISO treatment works out. Most states, including California, tax capital gains as ordinary income, so the state tax is the same either way.
Leaving a company with options: the 90-day window
Many option plans give you 90 days after your last day to exercise vested options before they expire; some companies offer longer windows. ISOs keep their special tax treatment only if exercised within three months after employment ends; if your plan allows a later exercise, those options are treated as NSOs.
At private companies this is a real trap: exercising can require a lot of cash, the shares can't be sold yet, and ISO exercises can trigger AMT. Before you leave, know your strike prices, the current 409A value, your exercise window and what exercising would cost, including tax.
Which is better?
At a public company, RSUs are simpler and never worthless while the stock trades above zero. Your job is to manage the withholding gap and your concentration in one stock.
At an early-stage startup with a low strike price and a realistic path to an exit, ISOs can save a lot of tax. But they require cash, carry AMT and liquidity risk, and only pay off if the company succeeds.
NSOs are taxed like RSUs at exercise, but you choose the timing and need cash to exercise.
Whatever you hold, the principle is the same: know what's withheld versus what you'll owe, and set the difference aside before you file.