Equity compensation can be a powerful way to build wealth—but it also comes with complicated tax rules.

Whether you’re granted restricted stock units (RSUs), non-qualified stock options (NSOs), or incentive stock options (ISOs), it’s important to understand how each type is taxed so you can plan ahead and avoid surprises.

Tax Implications of RSUs

RSUs are considered compensation, which means they’re generally taxed as ordinary income when they vest:

• When RSUs vest: The fair market value of the shares becomes part of your taxable income, just like salary or bonuses. This applies whether or not you sell the shares.
• Cost basis: The fair market value at vesting becomes your cost basis.
• Future sales: If you sell the shares later, any increase in value above your cost basis is taxed as capital gains (short- or long-term, depending on your holding period).

Ways to handle taxes when RSUs vest:

1. Same-day sale: All vested shares are sold immediately. Taxes are withheld, and you receive the net proceeds in cash.
2. Sell-to-cover: A portion of the shares are sold to cover tax withholding; you keep the remaining shares. This is often the employer’s default.
3. Cash transfer: You pay withholding taxes out-of-pocket and keep all the vested shares.

The Risk and Reward of an 83(b) Election

In some cases, employees may be able to make an 83(b) election. This allows you to pay tax on the value of stock when it’s granted rather than when it vests.

• Potential upside: If the stock’s value rises substantially, you lock in a lower taxable value early and benefit from long-term capital gains on future appreciation.
• Risk: If the stock price falls—or if you leave the company before vesting—you may end up paying tax on income you never actually receive.

Because the stakes are high, this decision should always be made with guidance from a tax professional.

Tax Implications of Exercising Stock Options

Unlike RSUs, stock options aren’t taxed when they vest. Taxes are triggered when you exercise or sell the shares.

• NSOs (Non-Qualified Stock Options):
  • The “bargain element” (fair market value at exercise minus the exercise price) is taxed as ordinary income.
  • Your cost basis becomes the fair market value at exercise.
  • When you later sell the stock, any additional gain is subject to capital gains tax.
• ISOs (Incentive Stock Options):
  • If you hold the shares at least one year from exercise and two years from the grant date, you may qualify for long-term capital gains treatment on the profit.
  • Selling earlier than these holding periods results in a “disqualifying disposition,” and part of the gain is taxed as ordinary income.
  • Exercising ISOs doesn’t always create immediate tax, but it can trigger the Alternative Minimum Tax (AMT) if the bargain element is large.

Alternative Minimum Tax (AMT) and ISOs

ISOs can be especially complex because of AMT. AMT is a parallel tax system designed to ensure high earners pay a minimum amount of tax. Exercising ISOs with significant appreciation can increase AMT liability, even if you haven’t sold the shares.

Careful planning is key—sometimes it makes sense to spread exercises across years or coordinate them with other parts of your tax picture.

Tax Reporting Requirements

When you exercise or sell equity, your employer and brokerage will report activity to the IRS, but the responsibility to track cost basis and calculate gains often falls on you.

• RSUs: Reported as income on your Form W-2; sales appear on Form 1099-B.
• NSOs and ISOs: Reported on IRS Forms 3921 and 3922, which help you determine cost basis and whether gains are ordinary income or capital gains.

Keeping thorough records is essential for accurate tax filing and avoiding double taxation.

Putting It All Together

RSUs, NSOs, and ISOs can be valuable tools for building wealth, but they require thoughtful planning to manage tax implications. The right strategy depends on factors like:

• Your income and tax bracket
• How long you plan to hold the stock
• Whether AMT applies
• Your broader financial and estate planning goals

Do You Have Employer Stock Options or Restricted Stock? Here’s What to do Next

At Navalign Wealth Partners, we can help you:

• Coordinate strategies with your retirement, estate, and tax planning goals
• Understand the tax treatment of your equity compensation
• Plan the timing of exercises or sales

Everyone has a unique financial situation that requires a tailored strategy to exercise stock options. If you need help creating a plan to exercise yours, we’re here to help. Schedule a complimentary consultation today, so we can help you put the pieces of your financial plan together.