ISOs, NSOs, and RSUs: The Tax Rules Nobody Explains Clearly
Henry Supinski, ChFC® · 6 min read · July 2026
Equity compensation comes in a few different flavors, and each one is taxed differently. Mixing them up is one of the most expensive mistakes a tech employee can make.
RSUs: Taxed the Moment They Vest
Restricted stock units are taxed as ordinary income when they vest, based on the share price that day. There's no election to defer it and no way to avoid it. Whatever you do afterward (hold or sell) only affects the capital gain or loss on top of that already-taxed amount.
NSOs: Taxed at Exercise, Not at Grant
Non-qualified stock options generate ordinary income at exercise, equal to the difference between the exercise price and the fair market value that day. That income shows up on your W-2 and is subject to withholding. Any further gain after exercise is a capital gain, taxed based on how long you hold the shares afterward.
ISOs: The One With the AMT Trap
Incentive stock options can qualify for favorable tax treatment (long-term capital gains on the entire gain) but only if you meet strict holding period rules and don't trigger the Alternative Minimum Tax along the way. Exercising ISOs and holding the shares can create an AMT bill even though you haven't sold anything and haven't received any cash. This is the single most common expensive surprise in equity compensation.
The Practical Takeaway
- RSUs: ordinary income at vest, no choice involved.
- NSOs: ordinary income at exercise, plus capital gains after that.
- ISOs: potential AMT at exercise, potential long-term capital gains treatment if holding rules are met, real risk if the stock drops after you've exercised and paid AMT on paper gains.
If your company has granted you more than one type, the right move (exercise, hold, or sell) is different for each one, and they interact with your overall tax bracket in ways that are easy to get wrong without modeling it out first.