Does Equity Count as Income for Tax Purposes?

Equity does count as income for tax purposes, and the question is not whether but when. Each form of equity compensation has its own trigger: for restricted stock units it is the vesting date, for non-qualified options it is the exercise date, for incentive options it can be delayed all the way to sale, and for partnership profits interests it may not happen at the grant at all. The rate you pay, the withholding you receive, and the traps you can fall into all follow from which trigger applies to you.

Restricted Stock Units Are Taxed at Vesting

RSUs are the most common equity award at public companies, and the rule is simple. On the day shares vest, the full fair market value of those shares is ordinary income, reported on your W-2 alongside your salary.¹ It does not matter whether you sell the shares or hold them. It does not matter what the company was worth when the grant was made. Vesting is the event.

Withholding is where people get caught. Employers withhold federal income tax on RSU income at the supplemental wage rate: a flat 22% up to $1 million and 37% above that. If your marginal rate is 32% or 35%, the 22% withholding leaves a gap you will owe the following April. State supplemental withholding often falls short in the same way. A large February vest can produce a surprise tax bill fourteen months later.

After vesting, your basis in the shares equals the amount already included in income. Anything above that when you sell is capital gain; anything below is capital loss. The holding period starts the day after vesting.

Non-Qualified Stock Options Are Taxed at Exercise

NSOs give you the right to buy stock at a fixed strike price. No income arises at grant. The taxable event is exercise, and the income is the spread between the fair market value on the exercise date and the strike price you pay. That spread is ordinary income, subject to income tax withholding plus Social Security and Medicare.²

Your basis in the acquired shares is the strike price plus the ordinary income recognized on the spread. If the price is $50 on exercise day and your strike was $10, you have $40 per share of ordinary income and a $50 basis for the eventual capital gain calculation.

Because you choose when to exercise, you can choose which year the income lands. Exercising in a low-income year can keep the spread out of your top bracket. Exercising in a year you have already earned into a high bracket stacks the spread on top of everything else.

Incentive Stock Options and the AMT Trap

ISOs are the most tax-favored option type. No ordinary income tax is owed at grant or exercise. If you hold the shares long enough, the entire gain from strike price to sale price is a long-term capital gain.²

The Two Holding Periods

To get capital gains treatment, you must hold the stock for at least two years after the grant date and at least one year after the exercise date. Sell before meeting both, and you have a disqualifying disposition: the spread at exercise (or the actual gain, if lower) converts to ordinary income, and only any gain beyond that gets capital gains rates.³

AMT Applies Even Without a Sale

The spread between strike price and fair market value at exercise is an Alternative Minimum Tax adjustment, reported on Form 6251, even though it is invisible to the regular tax system. For 2026, the AMT exemption is $90,100 for single filers and $140,200 for married couples filing jointly, with phase-outs beginning at $500,000 and $1,000,000.⁴ A large enough spread pushes you past the exemption and produces an AMT bill in the exercise year, with no cash from the shares to pay it. The classic disaster: exercise ISOs on a rising stock, owe AMT you cannot easily fund, watch the stock fall before the one-year mark.

ESPP Shares Are Taxed at Sale

A qualified employee stock purchase plan lets you buy company stock at up to a 15% discount through payroll deductions. Nothing is recognized at enrollment or purchase. The tax event is the sale.⁵

Hold the shares at least two years from the offering date and one year from the purchase date, and you have a qualifying disposition: ordinary income is limited to the lesser of the discount based on the offering-date price or your actual gain, with the rest as long-term capital gain.⁶ Sell earlier, and the full spread between purchase price and fair market value on the purchase date becomes ordinary income regardless of where the stock has moved since. Employees who sell each batch immediately to lock in the discount always trigger a disqualifying disposition, but the discount minus tax is still a guaranteed return.

The Section 83(b) Election: Choosing to Be Taxed Sooner

Section 83(b) lets you pay tax now on unvested equity so that all future appreciation is capital gain rather than ordinary income. It applies to restricted stock awards and to early-exercised options where the shares are subject to forfeiture. It does not apply to standard RSUs, because RSUs are a promise to deliver shares later, not a present transfer of property.¹

Making the election, you include in income the fair market value at transfer minus what you paid. Early-stage startup stock at $0.01 per share produces almost no current income. Your capital gains holding period starts immediately, and all later appreciation is taxed at capital gains rates when you sell.

The risk is one-way. If you leave the company and forfeit the shares, or the stock drops, you get no refund of the tax already paid, and you cannot deduct the forfeiture as a loss.

The 30-Day Deadline

The election must be filed with the IRS within 30 days of the property transfer. This deadline cannot be extended, and missing it by a day permanently forecloses the election for that grant.⁷ Filing Form 15620 electronically through your IRS account gives immediate confirmation. Mailing works if you use trackable delivery and keep the postmark. A copy of the election also has to be attached to your tax return for the year of transfer.

Contractor and Partnership Equity

Equity paid to a non-employee is self-employment income at the fair market value on the date it stops being subject to a substantial risk of forfeiture. Self-employment tax runs 15.3%, made up of 12.4% Social Security on net earnings up to $184,500 in 2026 plus 2.9% Medicare on all net earnings.⁸ The company reports the payment on Form 1099-NEC and withholds nothing. Quarterly estimated payments are on you.

Partnership and LLC equity comes in two flavors. A capital interest gives you a share of existing assets on hypothetical liquidation; receiving one for services is ordinary income equal to that liquidation value at grant. A profits interest gives you only a share of future profits and appreciation. Under IRS guidance, receiving a profits interest for services is generally not taxable at grant if certain conditions are met.⁹ Instead, income shows up as the partnership allocates profits to you. This is why LLC-structured startups favor profits interests for service providers.

What Happens After the Income Event: Capital Gains on Sale

Once equity has been recognized as ordinary income, subsequent price movement is capital territory. Your basis is what was already taxed. Anything above that when you sell is gain; anything below is loss.

Short-Term Versus Long-Term

Hold for one year or less and you have a short-term gain taxed at your ordinary rate. Hold longer than one year and the gain qualifies for preferential long-term rates.¹⁰ For 2026 those rates run 0% up to $49,450 of taxable income for single filers and $98,900 for joint, 15% above those thresholds up to $545,500 single and $613,700 joint, and 20% above.⁴ Most equity holders fall in the 15% band.

The Extra 3.8% NIIT

The net investment income tax adds 3.8% on top of capital gains when your modified adjusted gross income exceeds $250,000 (married filing jointly) or $200,000 (single), applied to the lesser of net investment income or the excess over those thresholds. The thresholds are not indexed to inflation.¹¹

Losses and the Wash Sale Rule

Capital losses first offset gains dollar for dollar. Excess losses can deduct up to $3,000 against ordinary income each year, $1,500 married filing separately, with the rest carrying forward indefinitely.¹² After a stock collapse, that cap can take years to work through.

The wash sale rule disallows a loss if you acquire substantially identical stock within 30 days before or after the sale. The disallowed loss adds to the basis of the replacement shares, so it is deferred rather than lost. For equity compensation this matters because RSU vesting counts as an acquisition. Employees on monthly or quarterly vesting schedules often find they cannot recognize losses on company stock at all, because a vest lands somewhere inside every 61-day window.

Covering the Tax Bill Before It Comes Due

Every form of equity income creates a withholding shortfall. RSU withholding at 22% often trails your actual rate. NSO exercises and ISO disqualifying dispositions produce spikes. Contractor equity has no withholding at all. The IRS expects you to close the gap with quarterly estimated payments or increased withholding from your salary.

For 2026, estimated payments are required if you will owe at least $1,000 after withholding and refundable credits, and your withholding covers less than the smaller of 90% of your 2026 tax or 100% of your 2025 tax. If your 2025 AGI exceeded $150,000 ($75,000 married filing separately), the 100% figure becomes 110%.¹³

Quarterly deadlines for 2026 are April 15, June 16, September 15, and January 15, 2027. When a large equity event lands in one quarter, pay the associated tax in that quarter rather than waiting for April. RSUs vesting in February with short withholding are best addressed with an estimated payment by April 15, which limits the penalty to that specific window.¹⁴

Quick Reference: When Each Type of Equity Becomes Taxable

RSUs: ordinary income at vesting, based on fair market value that day
Non-qualified stock options: ordinary income at exercise, based on the spread between market price and strike price
Incentive stock options: no ordinary income at exercise (AMT adjustment applies); taxed at sale as capital gains if the two holding periods are met, or as ordinary income if they are not
ESPP shares: taxed at sale, with the split between ordinary income and capital gains depending on whether holding periods are met
Section 83(b) stock: ordinary income at transfer (election within 30 days), with later appreciation as capital gains
Contractor equity: self-employment income when no longer subject to forfeiture
Partnership capital interest: ordinary income at grant, at liquidation value
Partnership profits interest: generally not taxable at grant; ordinary income as profits are allocated

1
Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection With Performance of Services
2
Internal Revenue Service. Topic No. 427, Stock Options
3
eCFR. 26 CFR 1.422-1 – Incentive Stock Options, General Rules
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Office of the Law Revision Counsel. 26 U.S. Code 423 – Employee Stock Purchase Plans
6
Internal Revenue Service. Stocks (Options, Splits, Traders) 5
7
Internal Revenue Service. Instructions for Form 15620
8
Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC
9
Internal Revenue Service. Revenue Procedure 2001-43
10
Office of the Law Revision Counsel. 26 U.S. Code 1222 – Other Terms Relating to Capital Gains and Losses
11
Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax
12
Office of the Law Revision Counsel. 26 U.S. Code 1211 – Limitation on Capital Losses
13
Internal Revenue Service. Form 1040-ES Estimated Tax for Individuals
14
Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty