Your Equity Comp, Explained: ISOs, NSOs, Restricted Stock and RSUs

Four award types look alike on an offer letter but are taxed on entirely different mechanics. This is a map of where the decisions live, including the elections, the deadlines and the California layer.

Equity is where compensation stops behaving like a paycheck. A salary arrives, tax is withheld, and the matter is largely settled. An option grant, a vesting schedule or a block of restricted stock is different. It carries decisions (when to exercise, whether to elect, how long to hold), and each decision quietly assigns the eventual gain a tax character before the money is ever in hand. The same award can produce a modest capital gains bill or a large ordinary-income one depending entirely on choices made along the way, often years before the shares are sold.

What makes equity compensation hard is that the four common award types look similar on an offer letter but are taxed on entirely different mechanics. One is driven by the alternative minimum tax. One is ordinary income at exercise. One offers a 30-day election that can reshape the entire outcome. One offers no election at all. Confusing them, or missing the window a particular award depends on, is among the most expensive mistakes a high earner can make, and unlike a missed deduction, it rarely announces itself until the return is prepared.

At a glance

• ISOs: no regular tax at exercise, but the spread counts for AMT. Hold one year from exercise and two from grant for long-term capital gain treatment.

• NSOs: the spread is ordinary income at exercise, withheld like a bonus.

• Restricted stock: taxed as it vests, unless you file an 83(b) election within 30 days of grant.

• RSUs: taxed as ordinary income when they vest, with no election available. Withholding is often short.

• California taxes all gains as ordinary income, runs its own AMT, and can tax equity earned here after you move away.

Incentive stock options (ISOs)

At grant: no tax.

At exercise: no regular income tax. But the spread between fair market value and the strike price (the "bargain element") is an adjustment for the alternative minimum tax, and a large exercise can create AMT with no cash coming in. AMT paid because of an ISO exercise usually generates a minimum tax credit (Form 8801) that can be recovered in later years.

At sale: a qualifying disposition, more than two years from grant and more than one year from exercise, makes the entire gain over the strike price a long-term capital gain. A disqualifying disposition, a sale before either date, turns the bargain element into ordinary income reported on your W-2, with any further gain taxed as capital gain.

Dual basis: for regular tax, your basis is the strike price. For AMT, it's the fair market value at exercise. Both must be tracked, because they drive the AMT gain or loss at sale and the recovery of the credit.

Example: strike $10, value $60, 1,000 shares, exercise and hold. Regular tax at exercise: none. AMT adjustment: $50,000, which may produce AMT. Sell 25 months later at $90 in a qualifying disposition: $80,000 of long-term capital gain, and the AMT credit begins to come back.

Non-qualified stock options (NSOs)

At grant: no tax, in the usual case.

At exercise: the spread is ordinary income, reported on your W-2 with payroll taxes and supplemental withholding. Federal withholding is often a flat 22% (37% on supplemental wages above $1 million), which is short for most high earners.

At sale: gain or loss beyond your basis (strike price plus the spread already taxed) is capital, long-term if held more than a year from exercise.

Watch for: the 1099-B basis trap. Brokers often report only the strike price as your basis. If that isn't corrected on Form 8949, the spread is taxed twice.

Example: strike $10, value $50, 1,000 shares. At exercise: $40,000 of ordinary income and a $50 basis per share. Sell 18 months later at $80: $30,000 of long-term capital gain.

Restricted stock (actual shares)

At grant: no tax while the shares are subject to a substantial risk of forfeiture, unless you make an 83(b) election.

At vesting: by default, the value of each tranche is ordinary income as it vests.

The 83(b) election: filed within 30 days of grant, it lets you pay ordinary tax on the value at grant (often very low for founders and early employees). All future appreciation becomes capital gain, and the holding period starts at grant. The risk: if the shares are later forfeited or fall in value, the tax paid isn't refunded. There is no late filing.

Example: 100,000 shares worth $0.01 each, four-year vesting. With an 83(b): $1,000 of ordinary income now, and a later sale at $5 produces roughly $500,000 of long-term gain. Without it: ordinary income on the value at each vest, potentially very large if the value climbs.

Restricted stock units (RSUs)

At grant: no tax. An 83(b) election isn't available, because units aren't stock.

At vesting: the full value is ordinary income on your W-2, automatically. Basis is the value at vesting.

Withholding: usually a sell-to-cover at the flat 22% federal rate (37% above $1 million). For households in the 32% to 37% brackets, plus California, that's often badly short. It's the single most common equity filing surprise.

At sale: gain or loss beyond the vest-date value is capital. The holding period starts at vesting, not grant. Watch for the same 1099-B basis trap: brokers sometimes report a $0 basis.

Example: 500 units vest at $80: $40,000 of ordinary income and an $80 basis per share. Sell 14 months later at $110: $15,000 of long-term capital gain.

Side by side

ISO	NSO	Restricted stock	RSU
Tax at grant	None	None	None, or value with 83(b)	None
Ordinary income	Only on a disqualifying sale	At exercise	At vest, or grant with 83(b)	At vest
AMT exposure	Yes	No	No	No
83(b) available	No	Only for early-exercise stock	Yes, 30 days	No
Holding period starts	At exercise	At exercise	At vest, or grant with 83(b)	At vest
Key trap	AMT and dual basis	1099-B basis double count	Forfeiture after 83(b)	22% withholding gap
Key forms	3921, 6251, 8801	W-2, 8949	83(b), W-2, 8949	W-2, 8949

The California layer

California broadly follows federal treatment of equity compensation, with four differences that matter. It has no lower rate for capital gains, so every gain is taxed at ordinary rates of up to 13.3%. It runs its own AMT, calculated on Schedule P, with its own credit carryforward. Its supplemental withholding rate on bonuses and stock compensation is 10.23%, which may be above or below your actual California rate. And it sources equity income by where you worked: if you move away, California can still tax the portion of an award earned while you worked here.

The engineer and the chess player

Every row in that table is engineering: precise rules, precise dates, precise forms. But the outcome isn't decided by any single row. It's decided by how the awards are sequenced against each other across years: which options to exercise in which year, which lots to sell first, when to let RSU income fill a bracket and when to keep room for an ISO exercise. That's the chess player's work, and it only happens if someone is looking at all of your grants together, several years ahead.

The bottom line

Across all four award types, one pattern holds: the tax outcome is set by decisions and deadlines, not by the sale itself. An ISO's advantage lives or dies on the AMT and the two holding-period clocks. Restricted stock's best outcome depends on a 30-day election most people never hear about until it has expired. RSUs under-withhold at exactly the income levels where the shortfall is largest. In each case, the return simply records a result that was chosen, often long before, by action or by default. The time to model it is before the next event, not at filing.

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Discuss your situation with Natalie C. Papagni, CPA

If you hold equity that is vesting, approaching an exercise decision or tied up with a move between states, a forward-looking review before the next event is the natural first step. A complimentary 30-minute consultation is a good place to start.

Natalie C. Papagni, CPA — Tax, Planning & Advisory Services 4275 Executive Square, Suite 200, La Jolla, CA 92037 (858) 754-8277 | service@lajollataxcpa.com | lajollataxcpa.com

Disclaimer: This material is provided for general educational purposes only. It is not tax, legal or accounting advice, and it does not create a CPA–client relationship. Tax outcomes depend on individual facts and circumstances, and figures and rules change from year to year. Consult a qualified professional about your specific situation before acting. Figures reflect 2026 federal and California rules; examples are illustrative.