When are Stock Options Actually Taxable? Avoid this Mistake + FAQs

Stock options (and similar equity grants) become taxable when you exercise them, when they vest, and/or when you sell the shares, depending on the type of option and how long you hold the stock.

In the U.S., different rules apply to different types of stock options – incentive stock options (ISOs), nonqualified stock options (NSOs), restricted stock units (RSUs), employee stock purchase plans (ESPPs), etc. – and both federal and state tax laws determine when and how much tax you owe.

Understanding these rules is crucial for employees, startup founders, and investors to avoid surprises.

We break down exactly when taxes are triggered for each kind of stock option, how federal vs. state taxes come into play (with a state-by-state breakdown), and key strategies (like 83(b) elections and AMT considerations) to optimize your tax outcome under 2024 and 2025 tax rules.

What you’ll learn in this guide: 🚀

• The specific taxable events for each type of stock option – when you owe taxes on ISOs, NSOs, RSUs, ESPPs, and more.

• Federal vs. state taxation of stock options, including a state-by-state table of how each state taxes stock option income.

• Key tax concepts and terms (AMT, 83(b) elections, qualifying vs. disqualifying dispositions, etc.) that impact stock option taxation.

• Real-world examples and scenarios (with tables) illustrating common outcomes, like exercising and selling vs. holding stock options, and the tax differences.

• Pros and cons of different strategies (early exercise, holding for long-term capital gains, 83(b) election, etc.) and common pitfalls to avoid.

• Comparisons of the tax treatment across ISOs, NSOs, RSUs, and ESPPs – and how taxes differ for employees, founders, and investors.

• Frequently asked questions from people on forums (Reddit, etc.) about stock option taxes – answered in a concise yes/no format for quick clarity.

Let’s dive in and demystify when stock options are taxable, so you can plan confidently and maximize your after-tax gains! 🎉

🕒 Timing Is Everything: When Do Stock Options Trigger Taxes?

Stock options and equity grants become taxable when a certain event triggers income or gain: typically at grant, vesting, exercise, or sale. The exact timing varies by the type of option or stock grant:

• Grant Date: Receiving a stock option grant usually is not a taxable event. Simply being granted an option (ISO or NSO) doesn’t create income because the option often has no “readily ascertainable value.” Exception: If an option itself had a clear market value (rare for employee grants), it could be taxable at grant – but in practice, this is uncommon. Similarly, receiving an RSU grant (a promise of future stock) isn’t taxed at grant because nothing of value is received yet.

• Vesting Date: Vesting means you’ve earned the right to keep your stock or options (often by staying employed for a period). For stock units or restricted stock, vesting is a taxable event. RSUs are taxed at vesting, because that’s when the stock is delivered to you. If you have restricted stock (actual shares subject to vesting), each portion that vests becomes taxable as you gain full ownership (unless you made an 83(b) election, discussed later). Stock options (ISO/NSO) don’t trigger tax at vesting – their tax comes at exercise or sale, not when they vest.

• Exercise Date: Exercising a stock option (buying the shares at the strike price) can trigger taxes:

  • For nonqualified stock options (NSOs), exercising is a taxable event. You owe tax on the “bargain element” (the difference between the stock’s fair market value at exercise and the exercise price you pay). This spread is taxed as ordinary income (compensation). Essentially, when you exercise an NSO and the stock is worth more than your strike price, it’s like your company gave you that difference as extra salary – so it’s taxed as such (and will be on your W-2 or 1099). We’ll detail this in the NSO section.

  • For incentive stock options (ISOs), exercising is not a taxable event under the regular federal tax system – however, it can trigger the alternative minimum tax (AMT). ISOs are special: no regular income tax at exercise, but the “spread” is still income for AMT purposes. If your ISO exercise is large enough, you may have to pay AMT in that year (we’ll explain AMT in depth later). If you exercise an ISO and don’t sell the shares by year-end, be aware of this phantom income for AMT. (If you sell ISO shares in the same year as exercise, then it becomes a “disqualifying disposition” – essentially taxed like an NSO, so no AMT in that case but you’ll have regular tax instead.)

  • For RSUs, there is no “exercise” step (the company just delivers shares at vesting), so this doesn’t apply.

  • For ESPP purchases, exercising isn’t the right term, but when you purchase shares through the ESPP, typically no immediate tax at purchase if it’s a qualified Section 423 ESPP. Taxes come later when you sell, but there are special rules depending on holding period – more on that in the ESPP section.

• Sale Date: Selling the stock acquired from options or equity grants is the other major taxable event. When you sell shares, you’ll owe capital gains tax on any increase in value since you acquired them. The key is the holding period:

  • If you sell the stock more than 1 year after acquiring it, any profit is a long-term capital gain, taxed at the favorable long-term rate (typically 0%, 15%, or 20% federally, depending on your income, plus possibly a 3.8% net investment tax for high earners). Long-term rates are usually much lower than ordinary income rates for high earners, which is why many strategies involve holding shares for at least a year.

  • If you sell the stock within 1 year of acquiring it, any profit is a short-term capital gain, taxed at ordinary income rates (just like your salary). Essentially, flipping the stock quickly yields no tax rate benefit.

  • For ISOs and ESPPs, there are additional holding period requirements to get preferred tax treatment: ISOs require holding until at least 1 year after exercise and 2 years after grant to be a “qualifying disposition.” ESPPs (qualified ones) require holding 1 year after purchase and 2 years after the start of the offering period to get their tax benefit. Meeting these periods can turn what would be wages into capital gains. Sell too early (a “disqualifying disposition”), and you’ll trigger some ordinary income (for ISOs, the previously untaxed spread becomes taxable; for ESPPs, the discount is taxed as wages). We’ll cover these specifics in later sections.

  • If the stock price fell below what it was when you acquired it, selling would produce a capital loss. Capital losses can offset gains and a small amount of ordinary income. Notably, with stock from options, if you paid taxes on income at exercise (like NSOs or disqualified ISOs) and then the stock dropped, you might end up with a capital loss that doesn’t fully make up for the tax you paid on the higher value. (This is a common pitfall – see mistakes to avoid.)

For most stock options, there are two main taxable points – exercise and sale – with the sale providing capital gain/loss treatment. For RSUs or restricted stock, vesting and sale are the points.

And the exact tax character (ordinary vs. capital gains) depends on how long you hold the stock after acquiring it and the type of option. Timing your exercise and sale decisions can dramatically affect your tax bill. ⏱️

Below, we’ll explore each type of stock option/equity grant and when taxes hit for that type, then we’ll delve into federal vs. state differences and strategies.

🔑 Key Tax Terms and Concepts (Building Your Stock Option Tax Vocabulary)

Before diving deeper, let’s define the key tax terminology and concepts that will come up when discussing stock options:

• Fair Market Value (FMV): The current market value of the stock. This is what the shares are worth (e.g. if your company is publicly traded at $50/share, FMV is $50). For private startups, FMV is typically determined by a 409A valuation. FMV matters at exercise (to compute the spread) and at sale (to compute gain).

• Strike Price (Exercise Price): The price at which you can buy the stock under your option. It’s set when the option is granted. For example, an option might allow you to buy shares at $10 each (the strike), regardless of the current market price when you exercise.

• Bargain Element (Spread): The difference between the stock’s FMV and your strike price at exercise. Example: Your strike is $10 and the stock is worth $30 at exercise – the bargain element is $20 per share. This “spread” is essentially the economic benefit you got by exercising – and it’s what gets taxed as compensation for NSOs (and counted for AMT on ISOs).

• Ordinary Income vs. Capital Gain: Ordinary income is taxed at your regular income tax rates (the same rates as your salary, up to 37% federal in 2024/2025, plus payroll taxes or state taxes). Capital gains are profits from selling assets (like stock) and can qualify for lower tax rates if long-term. When you exercise NSOs, the spread is ordinary income (wage income). When you later sell the stock, any further appreciation is capital gain. With ISOs (qualifying disposition), all the gain from strike price to sale price can end up as capital gain (hence their appeal). Short-term capital gains (asset held ≤ 1 year) are taxed like ordinary income; long-term capital gains (held > 1 year) get the lower rates.

• Alternative Minimum Tax (AMT): A parallel tax system designed to ensure high-income individuals pay a minimum tax. Certain “tax preference” items are added back for AMT calculations. Incentive Stock Options are a big one: the ISO bargain element (which is ignored under regular tax at exercise) is added to income for AMT. If your AMT calculation exceeds your regular tax, you pay the higher amount. AMT rates are 26% or 28% (flat, with an exemption amount that phases out at high incomes). In 2024, for example, the AMT exemption is about $81,300 for single filers (~$126,500 for joint) and phases out at higher incomes – meaning if you have a large ISO exercise, you can easily become subject to AMT. Good news: If you do pay AMT due to ISOs, you often get an AMT credit to use in future years (when your regular tax exceeds AMT, you can credit the earlier AMT, preventing double tax in the long run). We’ll cover strategies to handle AMT in context. Also note, a handful of states (e.g. California, Colorado, Connecticut, Iowa, Minnesota) have their own state AMT – meaning ISO exercises can trigger state-level AMT as well.

• 83(b) Election: A special tax election that applies to restricted stock (not options directly, but actual stock you receive that is subject to vesting). By filing an 83(b) election within 30 days of receiving restricted stock, you elect to pay tax on the stock’s value at grant rather than at vesting. Why do this? If the stock’s current value is very low (common for startups), you pay little to no tax now – and then all future appreciation can become capital gains (when you sell), rather than being hit as compensation at vesting. Founders and early startup employees often use 83(b) to lock in a low tax basis. Important: If you fail to file within 30 days, you lose the option – and then you’ll be taxed on the stock’s value as it vests (which could be much higher). Also, if the stock never ends up vesting (you leave early) or becomes worthless, you don’t get back the taxes you paid – that’s the risk of 83(b). (83(b) doesn’t apply to most stock options unless you early exercise an option to get stock immediately; more on that in the Founders section.)

• Qualifying vs. Disqualifying Disposition: These terms apply to ISOs (and ESPP shares). A qualifying disposition means you met the special holding requirements: for ISOs, you held the stock ≥2 years from grant AND ≥1 year from exercise before selling. For ESPPs, you held ≥2 years from the offering start AND ≥1 year from purchase. Qualifying dispositions get favorable tax: for ISOs, all profit is long-term capital gain; for ESPPs, you’ll have some portion taxed as ordinary (the initial discount, capped by a formula) but the rest as long-term capital gain.

• A disqualifying disposition is when you sell earlier than required – the ISO or ESPP essentially loses its special tax status. A disqualifying ISO sale means the bargain element at exercise becomes taxed as ordinary income (in the year of sale), and only any additional gain after exercise is capital gain. A disqualifying ESPP sale means the discount at purchase (the “bargain”) is taxed as ordinary income at sale. We’ll illustrate this with examples later.

• 409A Valuation: Pertinent to startup companies, a 409A valuation is an appraisal of the company’s fair market value used to set stock option strike prices. By law (IRC Section 409A), companies must grant NSOs and ISOs with a strike price at least equal to fair market value of the stock to avoid adverse tax consequences.

• This is more about option grant compliance than taxation timing, but worth knowing: if an option is granted with a strike below FMV (a “discounted option”), it can trigger immediate tax and penalties under Section 409A (essentially treated as deferred compensation). So, companies take care to price options correctly. For our purposes, we assume options are correctly issued (no immediate tax at grant).

• Payroll Taxes (FICA/FUTA): When stock option income is considered compensation, it may be subject to payroll taxes just like a bonus. For employees, NSO exercise income and RSU vesting income are subject to Social Security and Medicare taxes (FICA). Social Security tax (6.2% each from employee and employer in 2024) applies up to the wage base (~$160,200 for 2023, indexed for 2024), and Medicare tax (1.45% each, plus an extra 0.9% Medicare surtax on high earners’ wages) has no cap.

• ISO qualifying dispositions and long-term capital gains are not subject to FICA (they’re investment income, not wages). Also, ISO exercises (the untaxed spread) are not subject to FICA at exercise (even if you trigger AMT, AMT is income tax only).

• But if an ISO is disqualifying, the portion that becomes ordinary income is treated as wage income – typically added to your W-2 in the year of sale – and is subject to payroll taxes at that time. (One nuance: if you left the company, how payroll tax is handled can be tricky, but generally the income is still considered compensation for the year.)

• Withholding: Employers will withhold taxes on stock compensation when required. For NSOs, when you exercise and generate ordinary income, your employer will typically withhold federal and state income tax (and FICA) just like on a bonus. For RSUs, companies usually withhold a portion of the shares to cover taxes at vest (often using the IRS supplemental wage withholding rate – 22% federal up to $1M, and 37% for amounts beyond $1M – plus state withholding). Be careful: the default 22% might not be enough if you are in a higher tax bracket, potentially leaving you a tax payment due at filing time.

• For ISOs and ESPPs, no tax is required to be withheld by the employer at exercise or sale, even if you have a disqualifying disposition. That means it’s on you to pay any required estimated taxes – a common pitfall where people don’t realize they owe tax because nothing was withheld. Always consult a tax advisor when you exercise or sell – especially for ISOs where AMT can surprise you with no withholding.

• Section 1202 QSBS (Qualified Small Business Stock): This is a bit tangential but worth a mention for founders and early employees: If your company is a “C” corporation and the stock qualifies as Qualified Small Business Stock, and you hold the shares for ≥5 years after acquiring (and the stock was acquired at original issue, e.g. via exercise or grant), you might exclude a significant portion of the gain (potentially 100% of gain up to $10 million or more) under Section 1202. This is a huge tax benefit (0% tax on that gain). Stock obtained by exercising options can qualify. The key is the company must meet QSBS criteria (gross assets under $50M, certain business types, etc.). While not directly about when options are taxed, QSBS can affect the ultimate tax on a sale if you hold long enough. Founders and investors often plan around this. We won’t dive deeply here, but it’s an important “entity-based” optimization to know.

With these terms in mind, let’s examine each type of stock option or grant in detail – when each becomes taxable and how the tax is handled.

Incentive Stock Options (ISOs): Tax Benefits & Hidden AMT Traps 🏆

What are ISOs? Incentive Stock Options are a special class of stock option that can only be granted to employees (not consultants or board members) under a plan that meets certain IRS requirements (Section 422).

ISOs are prized because of their tax advantage: if you follow the rules, you pay no tax at exercise and all your profit can potentially be taxed as long-term capital gain when you sell the stock. That’s often a much lower tax burden than an NSO, which triggers immediate income tax at exercise. However, ISOs come with strings attached – notably the AMT and holding period rules.

When are ISOs taxable? There are two key points: at exercise (for AMT) and at sale:

• No regular tax at exercise: When you exercise an ISO, you do not owe regular federal income tax or payroll tax, no matter how large the spread. For example, if you exercise an ISO for 1,000 shares at a $1 strike when the stock’s FMV is $50, you have a $49,000 “bargain” gain – but under regular tax rules, that’s ignored at the time of exercise. This is a big benefit of ISOs.

• However, AMT may apply: That $49,000 will be counted as income for alternative minimum tax. So if you have a substantial ISO exercise, you might trigger the AMT for that year.

• Essentially, you may end up pre-paying some tax via AMT. The AMT calculation will compare tax on your income including the ISO spread (at 26% or 28%) vs. your normal tax without that income; if the AMT is higher, you pay the higher amount. In high-tax states, state AMTs can also hit (e.g. California imposes its own ~7% AMT). Planning ISO exercises often involves managing AMT – sometimes exercising incrementally to stay under AMT thresholds, or knowing you might pay AMT and using the AMT credit later.

• At sale – two scenarios:

  • Qualifying disposition (held long enough): If you hold ISO-acquired shares ≥1 year after exercise and ≥2 years after the grant date, it’s qualifying. In that case, when you sell the shares, all the difference between the sale price and your exercise price is taxed as long-term capital gain. Using the example above, say you held those shares and later sold at $80 per share. You originally paid $1, so you have $79 per share gain.

  • That $79,000 would be LTCG – taxed at 15% (or 20% if you’re very high income) instead of as wages. None of it is treated as ordinary income. (Meanwhile, you may have paid some AMT in the year of exercise on the $49 spread; if so, you’d get an AMT credit because now that $49 gain is being taxed under regular system as well – the mechanics can be complex, but the key is in the end you don’t pay tax twice on the same income. The AMT you paid can often be credited back in future years.)

  • Disqualifying disposition (sold too early): If you do not meet the holding requirements (for example, you exercise and sell the stock a few months later, or you sell just 6 months after exercise), the ISO is “disqualified.” The favorable treatment is lost. What happens is the bargain element at exercise becomes taxable ordinary income (just like an NSO would have been). This income typically is reported on your W-2 in the year of sale (even though no W-2 income at exercise). Any additional gain beyond the value at exercise is capital gain. Let’s illustrate: you exercise ISOs at $1 when stock is $50 (no regular tax then). Six months later you sell at $80. Because you didn’t hold 1 year, it’s disqualifying.

  • The bargain at exercise was $49/share – that $49,000 is now treated as wage income in the year of sale. The remaining gain from $50 to $80 ($30/share, $30,000 total) is capital gain – but since you held the stock only 6 months post-exercise, that $30,000 is a short-term capital gain (taxed at ordinary rates too). End result: in a disqualifying sale, you got no special benefit – the outcome is similar to if it had been an NSO all along (ordinary tax on $49k + ordinary on $30k, effectively). The one slight difference: timing – if you crossed tax years, you exercised in one year and sold the next, the tax events are split between years (AMT might have hit in exercise year, then regular tax on the W-2 income in sale year with an AMT credit possible).

ISO $100K rule: A quick note – the tax code limits how much value can first become exercisable as ISOs in a year. Only up to $100,000 worth of stock (based on grant-date values) that vests in one year can be treated as ISOs – any excess automatically becomes an NSO. This is usually handled by your company; it’s to prevent unlimited ISO grants. It affects primarily very large grants.

Employee perspective (ISOs): Employees love ISOs for the potential tax savings. But caution: Exercising ISOs means you are buying stock, often putting out cash, and possibly owing AMT, all while holding a stock that could fluctuate. Many dot-com era horror stories involved folks who exercised a ton of ISOs, incurred a big AMT bill on paper gains, and then the stock price collapsed – leaving them with stock they couldn’t sell and a tax bill they couldn’t pay. If you exercise ISOs, plan carefully:

• Sometimes people do a “same-day sell” (exercise and immediately sell the shares). This is actually a disqualifying disposition by definition (since you didn’t hold), meaning the ISO behaves like an NSO. You lose the long-term gain benefit, but you avoid AMT because selling in the same year cancels the AMT adjustment. Essentially, you’re cashing out and just paying ordinary tax on the spread. This might make sense if you need liquidity or want to avoid AMT risk. (Technically the IRS treats it as you sold the ISO option itself – but result is the same tax as NSO).

• If you want the tax benefit, you need to exercise and hold. Some strategies: exercise early in the calendar year (so that if the stock drops and you decide to sell before year-end, you can still avoid AMT since you sold same year); or exercise small amounts over multiple years to use up AMT exemption gradually; or exercise when your income is low (maybe a year you have deductions or lower salary) to minimize AMT.

• Remember no tax withholding on ISO exercise or sale – so budget for taxes if you do a disqualifying sale. Your employer should send you Form 3921 after an ISO exercise (an informational form showing the details) and if you sell, the broker will send a 1099-B; it’s on you (and your tax preparer) to report correctly.

Employer perspective: Employers do not get a tax deduction for ISOs unless the employee has a disqualifying disposition. In that case, the amount that became ordinary income for the employee is deductible to the company as compensation. Companies often like NSOs for the immediate deduction; ISOs trade that off for employee tax benefit.

Example: You have 10,000 ISOs at $5 strike granted in 2022, vesting through 2024. In 2024, the stock is $20 and you exercise all 10,000 (cost $50,000). FMV at exercise $200,000 → bargain element = $150,000. No regular tax now. However, $150K is AMT income – say your AMT exemption phased out and AMT applies at 28%, you’d owe roughly $42K AMT for 2024. Now you hold the shares. In 2025, more than a year later, you sell them at $30/share = $300,000. Your long-term capital gain (for regular tax) is $300k – $50k basis = $250,000. That $250k is taxed at, say, 15% = ~$37.5K. You also get to claim an AMT credit in 2025 for the AMT you paid – essentially offsetting some of that $37.5K if your regular tax exceeds AMT in 2025 (likely it will, since now you have a big regular capital gain). End result: roughly, you paid ~$42K in 2024 (AMT) and maybe get a chunk back via credit in 2025 (reducing your 2025 tax). Over both years, you paid tax on $250k gain at about a 15%-17% effective rate, instead of, say, 35%+ if it had been NSOs. This illustrates the benefit but also the cashflow issue of paying AMT a year earlier. If the stock had fallen to $10 instead, you might have paid AMT on a value you never realized – you’d then need to sell at $10 (disqualifying, because maybe you panic sell in 2025), and you’d end up with ordinary income at $20→$5 which overlaps with what AMT taxed… a complicated mess possibly resulting in a capital loss and unused AMT credit. (This is why planning is vital!)

In summary, ISOs are taxable at sale, not at exercise (for regular tax), but watch out for AMT at exercise. To maximize the benefit, hold the shares long enough to qualify for long-term capital gains. ISOs are great for potentially lower tax rates, but they concentrate risk (you’re holding stock) and can trigger AMT. Always consult a tax advisor about exercising ISOs, especially in large amounts. ✅

Nonqualified Stock Options (NSOs): Taxed at Exercise – No Free Lunch 💰

What are NSOs? Nonqualified Stock Options (sometimes called “Nonstatutory Stock Options”) are the more common type of option, especially in established companies or for grants to contractors, advisors, or anyone not eligible for ISOs. They don’t meet the special IRS criteria for ISOs – thus “nonqualified” for special tax treatment. The trade-off: NSOs are simpler but less tax-favored. Essentially, an NSO behaves like a cash bonus in the amount of the option gain, followed by owning stock.

When are NSOs taxable?

• Tax at Exercise: Exercising an NSO triggers ordinary income tax on the spread. Using a simple example: you have 1,000 NSOs with a $10 strike. The stock’s FMV is $30 when you exercise. You pay $10,000 to exercise (1,000×$10), and the shares are worth $30,000, so you got $20,000 of value for free. That $20,000 is taxable income to you, just like if your employer wrote you a $20k bonus check. It will be included in your W-2 as wage income (if you’re an employee) or on a 1099-NEC (if you’re a contractor or advisor). You’ll pay federal and state income tax on it, plus Social Security/Medicare taxes if applicable. Your employer is required to withhold taxes at exercise (for employees, usually withholding federal income tax at 22% or your supplemental rate, state tax, and FICA). If the amount is very large (and you’re an employee), the excess may fall under higher supplemental withholding (37% for the portion over $1M). Important: Even if you do a cashless exercise and sell immediately, this income is realized – essentially you sold the stock for $30k, paid $10k to exercise, and $20k is profit, which is wages. In a same-day sale, usually the broker or company will handle the withholding by taking a portion of sale proceeds. If you exercise and do not sell, you need to come up with cash to cover the withholding (some companies allow a same-day sale of some shares to cover taxes, or they might allow withholding of shares).

• No tax at vesting or grant: NSOs typically have no tax at grant or vest – the tax is all deferred until exercise. (There is a concept of early exercise: if allowed, you exercise options before they vest, receiving restricted stock. In that case, you’d file an 83(b) election to include the small spread at that time – since presumably FMV ≈ strike if you exercise right away – then as it vests you avoid further tax. This effectively converts the NSO into owning restricted stock. Not many companies allow early exercise of NSOs, but startups often allow it for ISOs. The net effect is you can start the capital gains clock early. For NSOs, early exercise doesn’t avoid the ordinary income on any bargain element, so you’d only do it if the bargain element is zero or very small.)

• Tax at Sale: After you exercise an NSO, you now own the shares with a basis equal to what you paid plus any income recognized. In our example, your cost basis in the stock becomes $30/share (the $10 you paid + $20 that was taxed as income). If you later sell the shares, you’ll have a capital gain or loss based on the difference between sale price and that $30 basis. If you sell soon after exercise at around the same price, there’s little to no capital gain (and likely short-term if within a year). If you hold the shares post-exercise, any further appreciation from $30 upward will be capital gain (hopefully long-term if you hold >1 year; any decline below $30 would be a capital loss if you sell lower). Unlike ISOs, there’s no special “qualifying” requirement – it’s just normal capital gains rules. Many employees choose to sell NSO shares immediately upon exercise (cashless exercise) to avoid the risk of holding stock – because you’ve already had to pay tax on the spread, holding the stock further is essentially investing your after-tax money in the stock. Some though will exercise and hold if they are bullish on the company, aiming for future appreciation now that the tax on the initial spread is “sunk cost.”

Employee vs. contractor: If you’re an employee with NSOs, the income at exercise is on your W-2 and subject to payroll taxes, as mentioned. If you’re a non-employee (e.g. an advisor or board member granted NSOs for services), the income at exercise is still ordinary income but reported on Form 1099-NEC (or potentially K-1 if you got it as partnership interest, etc.). It’s not subject to withholding, but you may need to pay quarterly estimated taxes. Also, non-employee comp might be subject to self-employment tax in some cases. The key is, regardless of employment status, the tax timing and amount is the same.

Example: You have 5,000 NSOs at $5 strike. The stock is $20 when you exercise all of them in 2025. You pay $25,000 (5k×$5) to buy the shares, which are instantly worth $100,000. You have $75,000 of compensation income. Assume combined federal/state tax ~35%; you owe about $26k in taxes (which your employer withholds from your paycheck or the exercise transaction). You might do a net exercise or sell some shares to cover this. Now, you hold shares with basis $20 each (total $100k basis). If you immediately sold all shares at $20, you’d just get your $100k, which covers the $25k you paid and the $26k tax (if you sold enough to cover it) – netting you around $49k cash. If instead you hold the shares, and later sell at $30, you’ll have a $10 gain per share → $50k capital gain, taxed at capital gains rates (say 15% federal = $7.5k + state). If the stock drops to $10 and you sell, you’ll have a capital loss of $10 per share → $50k capital loss, which can only offset other gains or up to $3k of ordinary income per year. Meanwhile, you already paid tax on that $75k “income” at exercise that evaporated. This illustrates why many choose not to hold after exercising NSOs unless they are confident in the stock’s prospects.

Planning NSOs: One strategy employees sometimes use is exercise-and-hold NSOs early in the calendar year if they plan to hold, so that if the stock tanks by December, they can sell by year-end and effectively the income would be lower (because the IRS can potentially adjust if you sold same year for less – essentially limiting the income to the value at year-end if you met certain criteria). But that’s risky and complicated. Generally, NSOs are straightforward: you get taxed when you make money (exercise), so many just exercise when they have a liquidity event (like company IPO or buyout) or do cashless exercises to turn it immediately into cash (paying tax in the process). Unlike ISOs, there’s no tax advantage to holding the option itself longer or special holding period after exercise (beyond the normal 1-year for LTCG on further gains).

Pros/Cons: Compared to ISOs, NSOs are simpler (no AMT, no holding requirements), but you pay more tax sooner. There’s no way to convert that initial gain into capital gain – it’s ordinary by design. One upside: because you pay tax at exercise, your basis is higher, so any later sale might have little or no extra tax if you sell quickly. In contrast, an ISO if sold qualifying triggers a big tax at sale (though at lower rate). For high-growth companies, ISOs give a clear tax edge; for lower-growth or stable stocks, NSO vs ISO difference might be small.

Employer perspective: The company does get a tax deduction equal to the ordinary income you recognize at exercise. That’s one reason companies don’t mind issuing NSOs (they get a tax write-off when you exercise), whereas they get no deduction for ISO exercises (unless you disqualify them). Companies will often favor NSOs for non-employees and for very large grants beyond the ISO $100k limit.

NSO vs. ISO choice: Sometimes early startup employees might get a mix or have to choose in some scenarios. Generally, if you can get ISOs, you’d take them for potential tax savings. NSOs might be reserved for late joiners, execs above the limit, or non-employees. Founders usually get stock not options, so it’s a different situation with 83(b).

In summary, NSOs are taxable when you exercise (ordinary income on the spot), and any later sale is separate capital gain/loss. There’s no deferring that initial tax (aside from simply waiting to exercise). Think of NSOs as “money now, taxed now.” Always plan to cover the tax at exercise; many use immediate sale of some shares to do so or exercise only when a liquidity event is imminent (like right before an IPO lockup expires, etc.). Unlike ISOs, no nasty AMT surprises – but also no special breaks.💡

Quick comparison of ISO vs NSO: Here’s a side-by-side of how ISOs and NSOs get taxed:

As you see, ISOs defer taxation to the sale (and potentially lower it), whereas NSOs tax you upfront at exercise. We’ll see RSUs next – which tax you even earlier (at vesting).

Restricted Stock Units (RSUs): Taxed at Vesting – Cash in Hand, Cash to Taxman 💵

What are RSUs? A Restricted Stock Unit is a grant of stock (or the cash equivalent) that you will receive in the future once certain conditions are met (usually continued employment until a vesting date). It’s called a “unit” because until it vests, it’s not actual stock, just a bookkeeping unit. Once an RSU vests, the company delivers you actual shares (or sometimes the cash value). RSUs have become very common at big tech companies and others as part of compensation packages.

When are RSUs taxable? At vesting. Vesting is the moment you “receive” the stock (it is transferred to you without restrictions). For tax purposes, that’s treated as if they paid you a bonus equal to the FMV of the stock on that date. Thus:

• Ordinary income at vesting: The value of the RSU shares at vest is taxed as wage income. It will appear on your W-2 (for employees) as income. All federal and state income taxes apply, plus payroll taxes (Social Security up to the wage base, Medicare, etc.). Your employer will withhold taxes by default – often by retaining some of the shares. A common method is the company withholds enough shares to cover the taxes and issues you the rest (known as net settlement). For example, if 100 RSUs vest and each share is $50 (total $5,000 income), the company might withhold, say, 22 shares for federal tax (if 22% rate) plus some for state, etc., and you’d get the remaining shares in your account.

• No tax at grant: When RSUs are granted, they’re just a promise. No tax until they vest and you actually get stock.

• No choice on timing: Unlike options, where you choose when to exercise, RSUs vest on a schedule – you don’t control the timing (aside from possibly leaving the company, which forfeits unvested RSUs). So you can’t defer the tax; when they vest, you owe it. One exception: some companies allow or require “deferred stock units” for executives, deferring delivery beyond vesting, but that gets into complicated deferred comp rules (409A again) and is not typical for most employees.

• Tax at sale: Once you have RSU shares (after vesting), any further change in stock price from the vesting date to when you sell will be a capital gain or loss. Usually, employees receiving RSUs will sell the shares immediately or periodically, since RSUs are often intended as immediate compensation (and many prefer not to hold too much employer stock). If you sell the shares right when they vest (or the moment they become sellable, e.g. after blackout period), then there’s essentially no capital gain – you just have the wage income. If you hold the shares, then any gain from the vest price is capital gain (long-term if held >1yr after vest, short-term if shorter). If the price goes down and you sell at a loss, you realize a capital loss that could offset other gains.

• Double-trigger RSUs (special case): In some pre-IPO companies, RSUs are structured to only deliver shares after both a time vesting and a liquidity event (IPO). Until the IPO happens, they don’t trigger tax. Once the IPO occurs (triggering event), a big lump of RSUs may vest/deliver. The tax effect is the same (ordinary income) but the timing was delayed until the company went public. This arrangement is to avoid taxing employees on illiquid stock. If you’re in this scenario (common in late-stage startups pre-2019 after some law changes), just know when that IPO happens, you might have a large tax hit because potentially several years’ worth of RSUs vest at once. Companies often coordinate withholding or allow same-day sales to cover tax in these events.

• Section 83(i) election (rare): The 2017 tax law introduced a provision (Section 83(i)) allowing certain employees at private companies to elect to defer tax on RSUs (and options) for up to 5 years post-vesting, if certain conditions are met (company must offer plan to most employees, etc.). It’s not widely used due to many restrictions (80% of employees must get grants, etc., and you risk owing tax later even if stock value falls). It’s an advanced strategy – if your startup offers this “Qualified Equity Grant” election, you’d know about it. Otherwise, assume RSUs = taxed at vest as usual.

Example: You have 1,000 RSUs that vest today. The stock is trading at $100 on vest date. You have $100,000 of wage income. Your employer withholds federal tax (let’s say $22k at 22% if this is not supplemental >$1M), state tax (varies, say $9k if 9%), Social Security ($6.2k on up to cap), Medicare ($1.45k, plus if you’re a high earner, maybe additional 0.9%). Roughly they might withhold around 40% total = $40k. They might take 400 of your 1,000 shares and sell them (or not even deliver them) to cover this, leaving you ~600 shares (or the cash equivalent of 600 shares). You end up with 600 shares worth $60k (or $60k cash if you sold those too). Now, your basis in those shares is $100 each (the amount taxed). If you sell them immediately at $100, no additional gain. If you hold them and later sell at $150, you’ll have $50 * 600 = $30,000 of capital gain. If you held >1 year, that’s long-term (maybe ~15% tax). If the stock drops to $80 and you sell, you have a capital loss of $20 * 600 = $12,000 (which you can use against other gains or up to $3k/year of ordinary income). But note, you already paid tax on $100k at vest – the government doesn’t refund that if the stock tanks; the best you get is capital loss relief. This is why many treat RSUs as income to be cashed out.

Planning RSUs: Since you can’t change the fact that they vest and tax then, the main decision is to sell or to hold after vesting. There’s a common saying: “RSUs are income, not an investment.” Treat them like a cash bonus – convert to cash (sell the shares) and invest/diversify as you see fit, unless you have strong conviction on the stock. Holding RSU shares essentially means you’re choosing to invest in your company’s stock with your post-tax money. That might or might not align with your diversification goals. There’s no tax advantage to holding RSUs for a year to get LTCG, except on future appreciation after vest – but you’re still heavily exposed to the stock for that to matter.

Pitfall: One mistake is not realizing the tax withholding may be insufficient. U.S. employers often withhold at the flat supplemental rate (22% federal) on RSU income. But if that RSU pushes you into a higher bracket (say you’re in the 35% bracket), you could owe more tax when you file. You might need to pay estimated taxes or extra withholdings. Some employers allow you to bump the withholding rate on RSUs. Check your situation; otherwise, come April 15, you could owe a chunk (plus possibly underpayment penalties if the amount is large and you didn’t cover it via safe harbors).

State sourcing: If you earned RSUs while working in different states, things can get complex – states may tax the income pro-rata based on where it was earned. For simplicity in this article we assume single-state scenarios, but just know multi-state RSU taxation requires allocation (your employer’s W-2 should do this if applicable).

In summary, RSUs are taxed when they vest as ordinary income. You don’t control that timing, so you focus on managing the resulting cash/taxes and deciding whether to hold or sell the shares. RSUs provide clarity (you know exactly what and when you get taxed) but also guarantee a tax hit even if you don’t sell, so plan accordingly.

Real-World Scenario Table – RSUs: Let’s illustrate the outcomes of different choices with vested RSU shares:

As shown, holding RSU stock can yield more upside (if stock rises, you get LTCG on new gains) but carries downside risk (stock falls and you already paid high taxes on value that disappeared). Many choose to sell ASAP to avoid that downside. The decision often comes down to your confidence in the stock vs. your risk tolerance with money that’s already been taxed.

Employee Stock Purchase Plans (ESPPs): Discounted Stock – Taxed at Sale, With Special Rules 🛍️

What are ESPPs? An Employee Stock Purchase Plan is a benefit that allows employees to buy company stock, usually through payroll deductions, often at a discount (commonly 10-15% off the market price). Qualified ESPPs under Section 423 have specific rules but offer a discount and deferral of tax until you sell the stock. Typically, employees contribute after-tax money during an offering period (e.g. 6 months), and at the end, the accumulated funds buy shares at a discount (often the discount is applied to the lower of the price at start or end of the period – a lookback feature).

When are ESPPs taxable? The act of buying shares through a qualified ESPP is not a taxable event. You’re buying stock at a discount, but you don’t report income at purchase if the plan meets Section 423 rules. Instead, taxes come when you sell the shares. The catch: similar to ISOs, ESPPs have qualifying vs. disqualifying dispositions that affect how the discount is taxed.

• No tax at purchase: Say your ESPP lets you buy at 15% discount. If the market price was $100, you paid $85. You immediately have $15 of gain on paper. Under a qualified ESPP, that $15 is not taxed at purchase. (In a non-qualified stock purchase plan, it would be taxed then, but most company ESPPs are qualified plans to get this deferral.)

• At Sale – Qualifying disposition: To get favorable treatment, you must hold the ESPP shares at least 1 year after purchase and 2 years after the offering period start (usually the grant date of the ESPP period). If you meet these, it’s a qualifying disposition. The tax treatment:

  • You will have to report as ordinary income the lesser of (a) the discount based on the offering date price, or (b) the actual gain. What does that mean? Essentially, you always have to at least count the built-in discount from the start of the offering as ordinary income, even in a qualifying sale. For example, if the offering began when stock was $100, and you got a 15% discount, that’s $15. Even if the stock is $200 when you sell, you only count $15 as ordinary income (the “ordinary income component” is capped by the discount off initial price). If the stock barely moved or went down, you instead count actual gain.

  • The rest of the gain is long-term capital gain. So in that example: Offering price $100, purchase at $85, sale at $200. Lesser of discount vs gain: discount = $15 (off $100), actual gain = $115 (from $85 to $200). Lesser is $15. So $15 per share is ordinary income. The remaining gain ($115 – $15 = $100 per share) is long-term capital gain.

  • If the stock went down and you actually sell for less than you paid, you wouldn’t have ordinary income beyond actual gain. In fact, if you sell for less than $85 in this example, you have a capital loss; and if it’s below $85, there’s actually no ordinary income because the “lesser of discount or gain” would be zero (no gain). (A nuance: if stock went down but still above $85, you might have some gain less than the original discount. Actually if it’s qualified disposition and you sell at a price between $85 and $100, your ordinary income is still the $15 discount cap, but you’d then have a capital loss for the difference, weirdly. However, many ESPP plans with lookback complicate what “offering date price” is – but let’s not overcomplicate here.)

• At Sale – Disqualifying disposition: If you sell the ESPP shares before 1 year or before 2 years from offering (whichever condition you broke), then it’s treated as disqualifying. Tax treatment:

  • You must report ordinary income = the discount at purchase (the difference between the price you actually paid and the stock’s FMV on the purchase date). Essentially, whatever “bargain” you got at the time of purchase becomes ordinary wage income in the year of sale. This is similar to an NSO exercise tax: you got value at purchase, so now it’s taxed as compensation.

  • Any additional gain after purchase is capital gain (short-term or long-term depending on holding period after purchase). If you held the stock less than a year, that additional gain is short-term (so effectively also taxed at ordinary rates, but reported as gain). If more than a year after purchase but you failed the 2-year from offering rule, that additional gain could be long-term. (Yes, you can have a scenario where you held >1yr so you get LTCG on part, but it’s still disqualifying because you didn’t meet the 2-year-from-offering rule.)

  • If the stock price went down and you do a disqualifying sale, the ordinary income is actually calculated as the lesser of the discount or the actual gain, similar to above logic, but for disqualifying it effectively means you report ordinary income up to the discount at purchase, but not more than your actual gain. If you sell at a loss overall, you wouldn’t report a phantom ordinary income; you’d effectively have no ordinary income (since gain is negative), and you’d have a capital loss. Generally, in disqualifying dispositions, companies will include the purchase discount as compensation on your W-2 if there was a gain.

It sounds complex, but here’s a typical outcome:

• Qualifying example: Stock at offering $20, you get 15% lookback discount so you pay $17 at purchase. On purchase day, stock is $22, but you still pay $17 (some plans use lower of start or end price). You hold one year after purchase. Now stock is $30 at sale. Original offering price $20, so discount was $3 off that. Actual gain = $13 (30-17). Lesser is $3 -> ordinary income. The remaining $10 is LTCG. If you’re in 24% bracket, you pay ~$0.72 on the $3 (24%) and 15% on $10 ($1.50). So about $2.22 total tax per share on a $13 total gain (~17% effective). Compare if it was disqualifying:

• Disqualifying example: Using same numbers but you sell immediately at $22 (right after purchase). Purchase price $17, FMV at purchase $22, sale $22. Ordinary income = $5 (the discount at purchase, since that was the FMV minus what you paid), and capital gain = $0 (you sold at the purchase FMV). Tax: $5 at ordinary rate (24%) = $1.20. That’s actually less in this case because the stock hadn’t risen much. But if the stock had spiked a lot:

• Disqualify scenario sale at $30 (but within months of purchase): Ordinary income = $5 (22-17), capital gain = $8 (30-22). The $5 is taxed at 24% ($1.20), the $8 is short-term, taxed at 24% as well ($1.92). Total $3.12 on $13 gain (~24%). Qualifying scenario was $2.22 (~17%) as shown. So qualifying saved money.

In summary: A qualifying ESPP sale essentially taxes the initial discount as ordinary but all growth beyond that as LTCG; a disqualifying sale taxes the discount at purchase as ordinary and the rest as ST or LT gain depending on holding.

No payroll tax on ESPP discount: Notably, the ordinary income from an ESPP (even disqualifying) is not subject to FICA payroll taxes. It’s a weird quirk: ESPP and ISO compensation from disqualifying dispositions is still considered compensation for income tax, but not for Social Security/Medicare. (This is good for the employee – you save those 7.65% taxes, and the employer doesn’t pay their half either.)

Employer reporting: If you do a qualifying disposition, you must self-report the ordinary income portion – your employer might not include it on W-2 because in a qualifying case, there’s technically no requirement for them to do so. (They often won’t know you sold or when; they do file a Form 3922 for ESPP giving IRS info on purchase.) If disqualifying, the employer will usually include the income on your W-2 (Code “ESPP” in Box 14 or such). Always double-check that you’re reporting correctly on your tax return; a lot of people get confused and double-count ESPP income or miss it.

Example numeric to tie it together:

• Scenario: You’re in an ESPP that offers a 15% discount with a 6-month lookback. At offering start, stock was $50. At purchase date 6 months later, stock is $60. You buy shares worth $60 for $42.50 (15% off the $50 lookback price, since $50 was lower than $60). Nice – you immediately have shares worth $60 that you paid $42.50 for. You got a $17.50 per share discount vs market. You buy 100 shares (so $4,250 paid, worth $6,000).

  • Qualifying hold: You hold these shares >1 year (and well >2 years from offering). Suppose you sell at $80. What’s taxed? Offering price was $50, purchase price $42.50. Discount off offering = $7.50 (50 15%). Sale gain = $37.50 (80-42.50). Lesser of $7.50 vs $37.50 is $7.50 -> ordinary income. The remaining gain ($30) is LTCG. Per share: $7.50 taxed ordinary, $30 LTCG. For 100 shares: $750 ordinary (maybe $75024%=$180 tax) + $3,000 LTCG ($3k*15%=$450 tax) = $630 total tax. If it had all been wages, 24% of $3,750 would be $900, so you saved a bit. If it had all been LTCG, 15% of $3,750 = $562.50, so you’re closer to LTCG outcome.

  • Disqualifying (quick sell): You sell immediately at $60. You held <1yr and <2yr, so disqualifying. Ordinary income = FMV at purchase – price paid = $60 – $42.50 = $17.50 per share (the actual discount realized at purchase, which matches 15% of $50 plus additional $10 because of lookback advantage; basically you got more than 15% off current price due to lookback). Since you sold at $60, your actual gain per share is $17.50 too. So $17.50 ordinary, and $0 capital. For 100 shares: $1,750 ordinary income (likely on W-2). Tax maybe $420 (24%). Compare to qualifying where tax was $630 on a $3,750 larger gain – well, in qualifying you made more money ($80 sale vs $60) so of course tax was more. But effective rate in qualifying was lower.

  • Disqualifying after 1 year but before 2 years: Suppose you held 18 months (so >1yr, so any gain is LTCG, but still <2yr from offering, so disqualifying). Say stock at 18 months is $80. Now: ordinary income = $17.50 (purchase discount relative to purchase FMV of $60) because disqual still uses purchase spread. Capital gain = $80-$60 = $20, and since held >1yr, it’s LTCG. So you’d pay tax on $17.50 as ordinary ($4.20) and $20 as LTCG ($3). Combined ~$7.20 on $37.50 gain (~19%). Qualifying would have been $7.50 ordinary + $30 LTCG as earlier – which is actually slightly more tax ($7.500.24 + $300.15 = $1.80 + $4.50 = $6.30). Wait the math: disqual in this scenario gave $17.50 ordinary ($4.20) + $20 LTCG ($3) = $7.20, which is a bit higher than $6.30. It can happen that if the lookback gave a bigger discount relative to purchase date, disqualifying can sometimes slightly increase taxes vs qualifying in certain ranges. But the differences are usually not huge; the bigger point is if stock skyrockets, qualifying saves a lot by making most gain LTCG.

The main takeaway: ESPP shares are not taxed until sale, but the discount will eventually be taxed at ordinary rates (somewhere), and holding the shares long enough converts the bulk of the gain into capital gains. If you need the cash or want to reduce risk, selling soon after purchase (even disqualifying) is perfectly fine – you still got your discount, you’ll just pay ordinary tax on that profit. Many treat ESPP as a way to get a quick 15% minus taxes profit every period (essentially free money). Others hold the stock if they believe in its upside and want more gains taxed as LTCG.

Planning: If you plan to sell immediately, it’s straightforward – budget for the tax on the discount (your employer typically does not withhold for ESPP sales, so you may owe taxes at filing). If you plan to hold, keep records of the offering date price, purchase price, etc., to correctly calculate the ordinary portion later. Your brokerage’s 1099-B might not do this calculation for you; they often just report full sale with basis = what you paid. You have to add the ordinary portion to your 1040 and adjust basis to avoid double-taxing it. It’s a bit tricky, so many people use tax software or accountants for this.

One more benefit: ESPPs can be a way for employees to invest in their company at a discount – just remember it increases your exposure to the company. And since it’s after-tax money you use to buy, you’ve already paid income tax on the earnings you put in (only the gain escapes until sale). Some high earners also bump into the annual $25,000 limit (you can’t purchase more than $25k of stock per year in a qualified ESPP, valued at offering price).

Pros: ESPP discounts are essentially free money if the stock stays flat or goes up. Tax deferral until sale is nice. Cons: If stock falls, you could lose money (though the discount gives some cushion) and still have some ordinary income to report in weird cases. And you have to tie up cash (payroll deductions) to participate.

That covers ESPPs. They’re a bit like a hybrid of options and RSUs in tax – no tax upfront (like options), but eventual ordinary component and capital gain (like ISOs).

Founders & Restricted Stock: Early Tax Elections (83(b)) & Special Considerations 👨‍💼🏗️

So far, we focused on employees receiving options or RSUs. Startup founders (and some early employees) often receive restricted stock rather than options. This means they are issued actual shares (often at a very low price per share when the company is brand new) which then vest over time or have buyback provisions. The tax rules for restricted stock fall under Section 83 – which says that if you get property (stock) as compensation that is subject to vesting (a risk of forfeiture), you don’t pay tax until it vests (since that’s when it’s no longer forfeitable). At vesting, you’d pay tax on the stock’s value at that time as ordinary income. For a founder, if you started a company and got, say, 1 million shares at $0.0001 each that vest over 4 years, by year 4 the company might be worth something and each vested tranche could be pricey – it’d be terrible to be taxed on that increased value.

Enter the 83(b) election: This is the critical tax tool for founders and early folks who get stock grants. If you file an 83(b) election within 30 days of receiving the restricted stock, you elect to be taxed now, at grant, on the stock’s current value as if it were not restricted. Essentially, you’re choosing to recognize income immediately, even though the stock isn’t vested yet. Why would you do that? Because when the stock’s current value is virtually zero (in a tiny startup), paying tax on that now is negligible – and then all future appreciation is not going to be taxed as compensation. Without 83(b), you’d pay tax at each vesting date on the then-fair value (which could be huge if the startup succeeds).

Founders scenario: Typically, founders purchase their shares at a nominal price (like that $0.0001 per share, reflecting just the par value or initial valuation). They then file 83(b) to tell the IRS “tax me on this now.” The income reported is essentially zero (because price = value, or maybe a few dollars). Now they hold the stock, and as it vests there’s no further tax because they already chose to include it in income. When they eventually sell the shares years later (hopefully for millions), all that gain can qualify as long-term capital gain (and potentially QSBS 0% tax if applicable, as mentioned earlier).

Example: Alice is a founder who gets 2,000,000 restricted shares vesting over 4 years. She pays $0.001 per share ($2,000 total) which the IRS agrees is fair value at inception. She files an 83(b). She reports $0 ordinary income (because she paid full FMV). Four years later, company is worth $5/share; she’s fully vested. She has paid essentially no tax so far. If she sells some stock, she’ll have capital gains from $0.001 to $5 – at long-term rates if >1 year from grant. If she had not filed 83(b), each vesting year she’d have to pay income tax on the value that vested. For example, 500k shares vest in year 1 at $1 value = $500k ordinary income to report; year 2 maybe $2 value = $1M income; etc. That would be disastrous cash-wise and would massively increase her tax basis in chunks. Founders basically must do 83(b) or the tax would be untenable.

Early employees with stock instead of options: Some startups give early hires actual stock (at a low price) with repurchase rights that lapse (equivalent to vesting). The same 83(b) logic applies – file it! If you pay something for the stock close to its FMV, your taxable income is small. If you get it for free, you’d pay tax on the nominal current value. Either way, you want to freeze that compensation income at the low value. Then as it vests, no tax events, and if you leave early and some unvested stock is forfeited, you already paid tax on it – which is a downside (no refund), but initial tax was likely minimal.

83(b) key points:

• Must be filed within 30 days of receiving the property. No extensions. It’s an actual letter/election you send to the IRS (and notify your employer). If you miss the window, you cannot retroactively get this benefit, barring a very unlikely IRS ruling granting relief.

• It applies to stock subject to vesting; it doesn’t apply to options themselves, but note: if your company allows early exercise of options (exercising before they vest), what you get by early exercising is restricted stock (unvested shares). You can then file 83(b) on those shares. This is a strategy some early employees use: they exercise their ISOs or NSOs early, when the strike equals FMV (no spread, so essentially no income), file 83(b) – meaning no tax now – and then as the shares vest, they won’t owe tax and any gain becomes capital gain. This combines the benefits of stock with the initial flexibility of options. Early exercising ISOs and 83(b) means you start the clock for long-term gains (and potentially ISO holding period) earlier, at the cost of paying to exercise upfront and risking money if you leave (you’d have paid for shares that you might have to sell back at cost).

• 83(b) is irreversible. If the stock doesn’t increase in value or you forfeit shares, you paid tax on value you never realized. But usually in startups the initial value is so low the tax was negligible.

• If the stock had some value and you paid less (bargain element), you’ll have to pay tax on that with 83(b). For example, a new hire gets 10k restricted shares for free, FMV $1 each (startup raised money). If they 83(b), they have $10k of income immediately (tax maybe $2k). If they don’t 83(b), they’d pay tax on each vesting piece – same total $10k, but spread over years, unless the stock value rises, then they’d pay more. Usually still better to 83(b) if you believe the stock will appreciate.

• Founders should also be mindful of QSBS: the 5-year clock for QSBS starts when you acquired the stock (and only counts if you held the stock, not options). By having stock early (and 83(b) so you actually own it despite vesting), founders start that clock so that 5+ years later any big sale/exit could qualify for QSBS exclusion. Another reason 83(b) is important – if you wait to be taxed at vesting, the QSBS holding period also starts at vesting, potentially missing out if an exit happens before 5 years from then.

Investors & Advisors: Typically investors buy stock in the company directly (not via compensation), so they just pay and get stock – no 83(b) issue because the stock isn’t compensation. They will just have capital gains when they sell normally. Advisors sometimes get NSOs – as mentioned, they’ll be taxed at exercise like any NSO, and they can’t get ISOs (since they’re not employees). Some advisors might receive restricted stock (common in very early stage as advisor shares) – if so, they should do 83(b) as well on that stock.

In short, for founders and anyone receiving actual shares subject to vesting, the key tax question is 83(b) or not. Almost always, the answer is yes, file it (if the initial value is low), because you convert what would be future high-tax wage income into low-tax (or no-tax) now and capital gains later. The only time you might not is if the stock is already somewhat valuable and you’re not sure it will grow – but even then, if you plan to stick around, you’d lean to do it.

Legal precedent or notes: Section 83 came about in 1969 after a famous case (Commissioner v. LoBue (1956)) and others where the IRS and courts wrestled with how to tax stock given to employees. LoBue established that if an employee gets a bargain (like cheap options), it’s compensation. Section 83 basically codified the timing: you’re taxed when you no longer have to give it back. The 83(b) election was introduced to allow people to elect earlier taxation (since sometimes earlier is beneficial, as we see).

Founders should also ensure proper 409A valuation on any stock sold to them if it’s not nominal, to avoid IRS argument that it was worth more (which could cause unwanted tax).

Finally, if a startup fails or a founder leaves and forfeits stock after 83(b), there’s no specific tax refund for previously taxed stock, but one might be able to claim a capital loss for the amount paid (which is often nothing or very little). The upfront tax paid on a zero purchase (just on FMV difference) is gone. It’s usually small, but just be aware.

Federal vs. State Tax Treatment: Uncle Sam vs. the States 🌎💵

So far, we’ve mostly discussed federal tax rules. State taxes can also take a bite out of your stock option gains. The good news: almost all states follow the federal timing and character rules for stock options. That is, if federal law says an ISO isn’t taxed at exercise, states also don’t tax at exercise (except via state AMT if they have one). If NSO exercise is ordinary income, it’s usually ordinary income for state too. But there are differences in rates and a few state-specific quirks:

• State Income Tax Rates: These vary widely. Some states have no income tax at all (so no tax on your stock option income): e.g. Florida, Texas, Washington, etc. Some have flat income tax rates (e.g. Pennsylvania 3.07%, Illinois 4.95% flat, Massachusetts ~5%). Others have high progressive rates (e.g. California up to 13.3%, New York ~10%, New Jersey 10.75%, Oregon 9.9%, Minnesota 9.85%, etc.). This means the state you reside in when you exercise or sell stock can greatly affect your net. For example, a $100k NSO exercise gain would incur $0 state tax in Texas vs. ~$10k in California.

• Capital Gains vs. Ordinary – State differences: Many states tax capital gains the same as ordinary income (most states do not give a special lower rate like the feds do). For instance, California taxes all income (salary or capital gain) at the same rates – no break for long-term gains. A few states do give a break:

  • Arizona and New Mexico allow a percentage of long-term capital gains to be excluded (e.g. NM lets you deduct 40% of capital gains or $1,000, whichever greater; AZ has a 25% exclusion on long-term gains from assets acquired after 2012 – though AZ’s tax is now a low flat 2.5% anyway).

  • Colorado, Idaho, Oklahoma have special exclusions for gains on stock of in-state companies held long-term (to encourage local investment).

  • Arkansas excludes 50% of long-term capital gains.

  • South Carolina excludes 44% of long-term gains.

  • Wisconsin excludes 30% of long-term gains (60% for farm assets).

  • Montana provides a credit effectively taxing long-term gains at 4.1% vs their normal 6.75%.

  • North Dakota excludes 40% of long-term gains (ND’s top rate is also low, recently about 2.5%).

  • Vermont allows a 40% exclusion on certain capital gains held >3 years (or a flat $5k exclusion).

  • Massachusetts surprisingly taxes short-term gains at a higher rate (12% historically, though recently it’s said 8.5% in some guidance) and long-term at 5%.

  • New York does not give a capital gains break generally (though NYC had a small one in past, not now).

  • Each state has its own nuances, but broadly, high-tax states tax your stock option income (whether wage or gain) heavily, while some states mitigate tax on investment gains.

• State AMT: As mentioned, a few states have their own Alternative Minimum Tax calculations. If you live in one, an ISO exercise can trigger state AMT too. For example, California imposes a 7% AMT. So if you exercise ISOs in California and have a large spread, you might owe CA AMT (even though under regular CA tax you wouldn’t owe until sale). Iowa and Minnesota have (or had) state AMTs as well, and Colorado and Connecticut did as of recent years. Many states abolished their AMTs, but CA still has it. Practically, if you pay AMT to California on ISO exercise, you also generate a CA AMT credit for future years (similar to federal).

• Source vs. Residence: If you move states, who taxes the stock option income? States generally tax residents on all income (with credits if another state also taxed some of it), and nonresidents on income sourced to that state (like compensation earned for work performed there). Equity compensation often accrues while you work in multiple states. For NSOs, states often allocate the income based on where you worked during the grant-to-exercise period. For RSUs, often allocation is grant-to-vest period. So, moving from California to Texas won’t automatically spare you California tax on all that stock comp – California may claim the portion that was earned while you worked there, even if you exercise/sell after moving. (California is particularly aggressive: if you earned options or RSUs during CA employment, they will tax the fraction of the income corresponding to CA work period, even if you moved before exercising). Conversely, states with no income tax don’t tax you after you move there, but they also don’t refund prior state taxes. Planning a move solely for stock option tax often doesn’t eliminate the tax – it just means the new state won’t tax it, but the old state might on a prorated basis. Still, there can be savings if the old state only taxes a portion or the new state’s rates are lower on any post-move appreciation.

• Local taxes: A few cities/counties have their own income taxes (e.g., New York City up to ~3.9%, some cities in Ohio, etc.). These will also apply to stock option income if you’re a resident there. California localities do not have separate income tax (except the SDI payroll tax and a new SF payroll expense tax possibly), but NYC is a big one to consider (NYC taxes capital gains as ordinary as well).

Let’s compile a handy state-by-state table of stock option taxation highlights, assuming you’re a resident in that state when the taxable event occurs (exercise or sale):

Key takeaways from state table: If you live in a state like California, expect to pay high taxes on your stock option profits, just as you do on salary – and remember ISO exercises can trigger state AMT. In no-tax states like Washington, Texas, Florida, etc., you avoid state taxes (aside from WA’s unique capital gains tax on big sales). Some states reward holding stock for long-term by giving partial exclusions (SC, NM, ND, WI, etc.).

If you are planning around state taxes:

• Consider timing and residency: If you know a big stock option event is coming (like an IPO or you plan to exercise a large amount), and you have flexibility to relocate to a lower-tax state well before the event, it could save you a lot. But be mindful of the “sourcing” rules – income earned from past work might still be taxed by your old high-tax state. For example, California will tax NSO exercise income proportional to how much of the vesting period you worked in CA. There is usually no escape for that portion except to pay and use a credit in the new state (but if new state has no tax, that credit is useless – meaning you just pay CA).

• For capital gains (like selling stock): Generally, the state you reside in at the time of sale taxes the gain. If you move to Texas and then sell stock that was not compensation (e.g. stock you’ve already exercised and just held), then only Texas (no tax) applies – your old state cannot tax capital gains after you left (except for real estate located there). So moving before selling appreciated stock can eliminate state tax on the sale. For ISOs, since tax is mostly at sale, moving to a no-tax state and then doing a qualifying sale can save a bundle. But any AMT paid in old state might be stuck (though you could plan exercise in new state too if possible).

• State AMT caution: If you live in CA or a similar state, even if you plan to hold ISOs for the federal benefit, budget for state AMT in year of exercise. CA’s AMT rate is 7% – not trivial.

• Credits: If two states tax the same income (like you lived in NY and then NJ when you exercised options), typically your state of residence will credit tax paid to the other state on the portion earned there. You generally won’t pay double tax, but you’ll pay the higher of the two states’ rates effectively.

In summary, always account for your state (and city) taxes when planning exercises and sales. The difference between 0% and 13% state tax on a $500k gain is $65,000 – worth considering! Some people relocate or at least time becoming a nonresident to coincide with cashing out equity (ensuring they comply with all residency rules). But do so carefully and ideally with tax advisor guidance, because states often scrutinize high-income moves.

Comparing Stock Option Types and Strategies 📊

We’ve covered each type of equity and their tax triggers. Let’s pull it together with some comparisons to highlight how they differ in practicality and outcomes:

Tax Timing & Rates:

• ISOs: No regular tax until sale; potentially all gain at favorable LTCG rate if qualifying. But risk of AMT at exercise (accelerated tax).

• NSOs: Taxed early (at exercise) at high ordinary rates, then any later gain as cap gain. So you pay some tax sooner/higher, but then basis is raised.

• RSUs: Taxed earliest (at vesting) at ordinary rates on full value – essentially treated as salary. Then later gains as cap gain.

• ESPP: Not taxed until sale; portion of gain (the discount) always ordinary, rest can be LTCG if held long enough.

• Founders Stock (Restricted with 83(b)): Taxed extremely early (at grant, usually negligible), then nothing until sale – all sale gain LTCG (often QSBS 0% if applicable).

So on a spectrum of “tax now vs tax later”: RSUs tax now; NSOs tax at exercise; ISOs and ESPPs tax later at sale (with caveats like AMT or ordinary portion); founders stock tax at the very start (small) and then at end.

Who gets what:

• Employees at big companies: often get a mix of RSUs and NSOs. RSUs give immediate value (with tax) and NSOs give upside potential (with ability to time exercise). ISOs are common in startups or smaller companies for rank-and-file employees.

• Startup employees: often get ISOs (or NSOs if they’re contractors or beyond the $100k limit). They might early exercise for 83(b) if allowed.

• Founders: get stock (83(b) recommended).

• Investors: usually just buy stock (so their scenario is straightforward capital gains on sale, perhaps QSBS).

• Executives in public firms: may get NSOs (if ISOs cap out) and performance stock units (like RSUs with targets).

Risk vs Reward:

• ISOs let you defer tax and possibly get lower rates, but you take on the risk of holding the stock (and potential AMT cost) without cashing out.

• NSOs force you to “prepay” tax when you exercise – you give IRS their cut even if you haven’t sold the stock for cash. That adds risk if stock falls after.

• RSUs give you no choice but also no risk on the initial value – you are given stock and taxed, but you could immediately sell to cover tax and keep the net. It’s more like cash bonus in stock.

• Founders stock with 83(b) is best tax-wise (low initial tax, all growth potentially LTCG), but obviously founders are already all-in risk on the company’s success.

Flexibility:

• NSOs offer timing flexibility: you choose when to exercise (maybe align with low income year, or after stock dips to reduce tax, or just wait until exit).

• ISOs also give some flexibility but you might lose ISO status 90 days after leaving a job (important: upon leaving, ISOs typically expire or become NSOs if not exercised within 90 days). So sometimes employees must exercise ISOs within 90 days of quitting to retain ISO treatment.

• RSUs offer no flexibility on when income happens (vesting schedule fixed), but you can choose when to sell after vest (though many companies have automatic sale for taxes or allow immediate sale).

• ESPP you can choose when to sell after purchase (immediately or hold for qualifying).

• Founders stock no flexibility needed; you already have it, just hold until a liquidity event.

Pros and Cons Table: Let’s summarize the advantages and disadvantages of each type from a tax perspective:

From the above, you can see:

• ISOs vs NSOs: ISOs win on tax rate (if you can hold), but NSOs win on simplicity/avoid AMT. If your company is small and likely to skyrocket, ISOs are golden (just manage the AMT). If the growth is modest or you intend to sell quickly, NSOs end up similar (since ISO benefit only comes with holding).

• RSUs vs Options: RSUs are easy but always taxed as income; options require action but can yield better tax (capital gains) if managed. Companies often give RSUs when they want to ensure employees get value (even if stock stays flat, RSUs have value; options would be worthless if stock doesn’t rise).

• ESPP is kind of a no-brainer benefit if you can afford it – the discount is free money, and worst-case you sell immediately and pay ordinary tax on that small spread, netting maybe ~10% profit after tax on each period’s contribution (assuming 15% discount and say ~30% tax on it yields ~10.5% net profit, which is great for a 6-month investment).

• 83(b) for founders/early employees – a must in most cases. The “cons” are trivial compared to the tax catastrophe of not doing it and then the startup succeeding.

Common Mistakes to Avoid 🚫

Dealing with stock options can be complicated. Here are some frequent mistakes and pitfalls that taxpayers should be careful to avoid:

• Failing to file the 83(b) election (or missing the deadline): For anyone receiving restricted stock (including early exercised options), forgetting to file an 83(b) within 30 days is probably the costliest mistake. It can turn a near-zero tax event into hundreds of thousands in taxed income later. Solution: If you get unvested stock, mark that 30-day deadline immediately, prepare the letter and send it certified mail with return receipt to the IRS. Keep proof of mailing and a copy of the election. If you realize you missed it, talk to a tax advisor immediately – getting relief is extremely rare, but worth exploring if huge amounts are at stake.

• Getting hit with surprise AMT from ISOs: Many people exercise ISOs late in the year without realizing it can trigger AMT. Come tax time, they are shocked to owe tens of thousands in AMT for stock they haven’t sold (and maybe that went down in value). Solution: Always estimate AMT before exercising a large ISO batch. Consider exercising early in the calendar year or in smaller tranches to manage AMT, or sell some shares in same year of exercise to avoid AMT (though that makes it disqualifying). If you already did and are now facing AMT, remember to claim the AMT credit in subsequent years. Also note that if your ISO exercise plus other income still falls under the AMT exemption, you might be fine – do the math or consult a professional beforehand.

• Not withholding enough tax on NSO exercises or RSU vesting: Employers often withhold at minimum rates. If you’re in a higher bracket (which big stock windfalls often push you into), that default withholding may be short. You could end up owing a big amount on April 15 and possibly penalties. Solution: If you know you’re in a high bracket, instruct your employer to withhold a higher flat percentage or make estimated tax payments yourself. For example, RSU vest of $500k might only have $110k withheld (22%), but if you’re at 35% marginal, actual tax is $175k – you’d owe $65k later if you don’t act. Many brokerage platforms also allow you to elect to withhold at the supplemental max 37% for federal if you prefer.

• Holding too much stock without diversifying (post-tax risk): This isn’t purely a tax mistake, but it’s related. Sometimes to get long-term capital gains, people hold onto a huge portion of their net worth in one stock (their employer). The risk of a drop can outweigh the tax savings. Example: Holding an RSU after vest to save maybe 15% in tax on future growth, but the stock drops 50% – the tax savings pale compared to the loss. Solution: Have a strategy. Maybe sell enough to cover your tax and some to diversify, and only hold what you’re willing to speculate with. Don’t let the “tax tail wag the dog” – i.e., don’t keep a risky position just to hopefully get a lower tax; sometimes paying some tax and locking in a sure gain is wiser. If you have ISOs and the stock soared, consider selling some after a year to at least cover your AMT or initial costs, etc.

• Not understanding state tax impacts (especially after moving): As discussed, moving states can be tricky. One mistake is assuming “I moved to Texas, so none of my stock option income will be taxed by California now.” If that income was earned during your California employment, California can still tax a portion. Conversely, some move to CA and don’t realize even pre-existing stock gains might become partly taxable to CA once you’re a resident (CA taxes all your income while resident, but you’d usually get credit for taxes to other states on the portion earned before moving). Solution: When moving, consult a multi-state tax expert. Keep detailed records of when stock was granted, where you worked during vesting, etc. File nonresident returns as needed. Some states (like CA) have you allocate based on days or months of service in and out of state.

• Forgetting to report stock sales properly (double counting income or missing basis adjustments): A common tax prep mistake: You sell stock from an ISO/NSO/RSU and get a 1099-B for, say, $100k proceeds. You also have $80k of that reported on your W-2 as income (for an NSO exercise/same-day sale or RSU vest sale). If you just plug the 1099-B into tax software without adjusting basis, it might think you have $100k gain (and tax you again), whereas your basis is $80k (the amount already taxed as comp) plus strike. Many taxpayers either get a CP2000 notice for not reporting 1099-B at all (because they assumed W-2 covered it), or they report it but don’t adjust basis and overpay tax. Solution: Always reconcile your 1099-B with your W-2. For same-day sales, your gain is often very small (just the fee or slight price moves). Make sure to input the correct cost basis (which in a same-day exercise+sell = strike price + compensation income). The brokerage may provide an “adjusted cost basis” in supplemental info, but often it’s not on the 1099-B itself. For ESPP, as mentioned, you must add the compensation portion to your basis to avoid double taxation. There’s IRS guidance on this; many tax software have an interview question “did you have compensation reported for this sale?” Use those.

• Not planning around expiration or job changes: Stock options (ISO/NSO) typically expire after ~10 years or 90 days after leaving the company (for ISOs). If you don’t exercise in time, they lapse worthless – a real waste if they were in the money. Some people delay too long or forget. Also, if you’re leaving a company, your ISOs will lose ISO status after 90 days, converting to NSOs (meaning any later exercise won’t get ISO benefits). Solution: Mark your calendar for option expirations. If you plan to leave, decide if you will exercise some or all of your options before the 90-day post-termination window ends. If you have ISOs and can’t afford to exercise them all, maybe exercise some that have large spread to at least preserve their ISO treatment (or to just capture value). Or negotiate with the company if possible – nowadays some startups extend post-termination exercise periods or convert to RSUs, etc., but that’s case-by-case.

• Assuming all equity comp is taxed the same or not consulting a professional for large transactions: Equity comp has nuances. Many mistakes come from assuming wrong things (e.g., “I won’t owe tax until I sell the shares” – true for ISO, false for NSO/RSU; or “the company withheld tax, so I’m all set” – sometimes incomplete). Solution: If you are dealing with life-changing sums or unfamiliar situations (like an IPO, a tender offer, an acquisition payout in stock, etc.), invest in a session with a CPA or financial advisor who understands equity comp. It can save you from costly missteps and identify opportunities (like 83(b), tax-loss harvesting if stock drops after you paid tax, using AMT credit, etc.).

Avoiding these mistakes requires attention to detail and sometimes advice – but it can make a difference of many thousands of dollars and a lot of stress. ✅

Content Clusters & Further Reading 📚

(Internal linking suggestions for a comprehensive understanding of equity compensation and taxation):

To deepen your knowledge, consider exploring these related topics in our Equity Compensation series:

• “AMT and Stock Options: Strategies to Reduce Alternative Minimum Tax” – a guide on calculating AMT with ISO exercises and using strategies like sell-to-cover and AMT credit recovery.

• “Section 83(b) Elections Explained – How and Why to File (with Examples)” – a focused article on 83(b) with step-by-step filing instructions and case studies of founders.

• “NSO vs. ISO: Key Differences in Tax and When to Use Each” – a comparison piece to help companies and employees decide which type of option to grant/exercise.

• “Restricted Stock Units vs. Stock Options: Which is Better?” – discusses the pros and cons of RSUs and options for employees, including tax timing and value considerations.

• “Planning for an IPO or Acquisition: Tax Tips for Equity Holders” – how to handle lock-up expiration sales, qualified small business stock (QSBS) considerations, and state residency planning before a liquidity event.

• “Tax Filing for Equity Compensation: Forms and Reporting” – a walkthrough of Form W-2, 3921 (ISO), 3922 (ESPP), 1099-B, Schedule D, etc., to ensure you report everything correctly at tax time.

(These topics form a cluster around stock option taxation and can be interlinked for users seeking a comprehensive mastery of equity compensation and taxes.)

FAQ: Frequently Asked Questions

Q: Do I owe tax when I exercise incentive stock options if I don’t sell the shares?
A: No, not under regular tax rules – exercising ISOs isn’t a taxable event for ordinary tax. However, it can trigger AMT if the spread is large, so you may owe AMT for that year.

Q: Are ISO exercises subject to Social Security and Medicare taxes?
A: No, ISO exercise income isn’t subject to FICA. In a qualifying ISO, there’s no wage income at exercise or sale. Even a disqualifying ISO is reported as wage income when you sell, but it’s exempt from Social Security/Medicare taxes.

Q: Can I avoid taxes completely by never selling my stock option shares?
A: No. You defer taxes by holding, but eventually when you sell you’ll pay tax on the gain. The only exception is if the stock qualifies for a special exclusion (like QSBS held >5 years, which can eliminate federal tax – but state taxes may still apply).

Q: If I move out of California, will California tax my stock option income?
A: Yes, California will still tax the portion of option income earned while you worked there. Moving can reduce future income being taxed by CA, but CA will claim tax on compensation for California-based work (even if realized after leaving).

Q: Do I have to pay state taxes on capital gains from stock options?
A: Yes, if your state has income tax, it typically taxes capital gains too (often at the same rate as ordinary income). A few states have special lower rates or exemptions for capital gains, but most will tax your stock sale gains.

Q: Does an 83(b) election apply to stock options?
A: Yes, indirectly – you file 83(b) when you receive stock. If you early-exercise options to get unvested shares, you can then file 83(b). You cannot file 83(b) on an unexercised option itself.

Q: Can I file an 83(b) election after 30 days of getting my stock?
A: No, not without IRS consent (which is rarely given). The 30-day deadline is strict. Missing it means you can’t retroactively elect – you’ll be taxed as shares vest.

Q: Is the 90-day exercise rule for ISOs a tax rule?
A: Yes, for ISO qualification. If you leave a job, you generally must exercise ISOs within 90 days to keep their ISO status. After 90 days, they become NSOs (taxed at exercise). It’s not an IRS “penalty” but a requirement to get ISO treatment.

Q: Will exercising a bunch of NSOs in one year push me into a higher tax bracket?
A: Yes, it can. NSO exercise income is like a bonus – it’s added to your salary and could push you into a higher federal and state bracket, phasing out deductions/credits. Plan for a higher marginal rate on that income.

Q: If my company stock price drops after I pay tax on RSUs, can I get a tax refund?
A: No. Once you’ve paid tax on RSU income at vesting, a later drop only gives you a capital loss if you sell lower. You can use the loss to offset gains (and up to $3k of ordinary income per year), but you don’t get back the wage taxes you paid.

Q: Do I need to report an ISO exercise on my tax return if I didn’t sell the stock?
A: Yes, but only for AMT purposes. You’ll file Form 6251 (AMT) and include the ISO spread as an AMT adjustment. If you aren’t in AMT range, it won’t affect regular tax, but it’s reported. The company will send Form 3921 for info – you don’t include that in regular income.

Q: My employer withheld taxes on my RSU vest – does that cover everything I owe?
A: No, not always. Employers typically withhold at a flat 22% federal rate on supplemental income (RSUs) up to $1M, which might be insufficient if you’re in a higher bracket. You may owe additional tax when you file your return.

Q: If I do a same-day exercise and sell of NSOs, will I have to pay capital gains tax?
A: No. In a same-day exercise/sell, the gain is all treated as ordinary wage income (the difference between strike and sale price). There’s virtually no capital gain since you sold immediately at FMV. You’ll be taxed on that spread through payroll.

Q: Can I qualify for long-term capital gains on RSUs?
A: Yes, but only on growth after vesting. The RSU value at vest is already taxed as ordinary income. If you hold the shares post-vesting, any increase from the vest price can be LTCG if held >1 year. The RSU’s initial value doesn’t get LTCG treatment.

Q: Do stock options count as income for IRA or 401(k) contribution limits?
A: Yes, if it’s compensation income. NSO exercise income and RSU vest are W-2 wages, which count as earned income for IRA contribution eligibility and allow 401(k) deferrals (some employers even allow you to contribute bonus/option income to 401k if within limits). ISO exercises that aren’t taxed don’t create W-2 income at the time, so they wouldn’t count until possibly later if disqualified.

Q: Can I use capital losses to offset my stock option ordinary income?
A: No. Capital losses offset capital gains fully, but they only offset up to $3,000 of ordinary income per year. So if you have a huge capital loss (say from stock you sold), it can only modestly offset salary/option ordinary income beyond that $3k. You can carry losses forward, however.

Q: If I inherited stock options, do I get a step-up in basis?
A: No for options themselves; Yes once exercised if stock is inherited. Inherited assets get a basis step-up to FMV at death, but stock options are not capital assets until exercised. Non-transferable options usually lapse or can sometimes be exercised by an estate (if plan allows) – those exercises would create income to the estate/beneficiary. If the option was exercised before death and stock held, then the stock gets step-up. In short, inherited stock (from exercised options) gets step-up, but an unexercised option does not magically erase the income tax if exercised later.