How Stock Grants Are Taxed: RSUs, ISOs, ESPPs, and the AMT Trap

Stock grants from an employer are taxed in two stages: first as ordinary income when the shares become yours (at vesting, exercise, or purchase, depending on the grant), then as a capital gain or loss when you later sell them. The ordinary income piece is taxed at your regular federal rate and also carries Social Security and Medicare tax; the later sale follows capital gains rules, with long-term rates that can be as low as 0%. How stock grants are taxed depends heavily on which type you hold, so the specifics for RSUs, restricted stock awards, NSOs, ISOs, and ESPPs each work a little differently.

The Two Tax Events Behind Every Grant

Almost every stock grant produces income in two categories, and knowing which applies at each stage is the foundation for everything else.

The first is ordinary income: the difference between what you paid for the stock (often nothing) and its market value at the moment the shares become yours for tax purposes. This is taxed at your regular federal rate and is also subject to Social Security tax (6.2% up to the wage base) and Medicare tax (1.45%, plus an additional 0.9% on earnings above $200,000 for single filers). Your employer withholds on this income and reports it on your W-2.

The second is capital gain or loss, which arises when you sell shares for more or less than your tax basis. Held for one year or less, any gain is short-term and taxed at your ordinary income rate. Held longer than a year, the gain is long-term, which for 2026 means 0% on taxable income up to $49,450 for single filers ($98,900 for joint filers), 15% up to $545,500 ($613,700 joint), and 20% above those thresholds.¹²

The grant type determines which date triggers ordinary income and what your cost basis becomes for the later capital gains calculation. Get this wrong and you can pay tax on the same dollars twice or miss a required payment entirely.

Restricted Stock Units (RSUs)

An RSU is a promise: your employer agrees to deliver shares after you satisfy a vesting condition, usually continued employment. You own nothing until the vesting date, which makes the tax treatment straightforward.

On the vesting date, the full market value of the delivered shares is ordinary income. If 100 shares vest when the stock is trading at $50, you have $5,000 of W-2 income that day. Your employer withholds federal income tax, typically at the flat 22% supplemental wage rate (37% on amounts over $1 million in a calendar year), plus Social Security and Medicare taxes.³ Many companies handle this through sell-to-cover, automatically selling enough shares to pay the tax and depositing the rest into your brokerage account.

That $50 per-share market value on the vesting date becomes your cost basis. Sell at $65 six months later and the $15 per-share gain is short-term. Wait more than a year from the vesting date and the same $15 gain qualifies as long-term.¹

Watch the withholding rate. The 22% supplemental flat rate often falls short of the actual tax owed, especially if the vesting event pushes you into the 32% or 35% bracket. You’ll owe the difference when you file.

Restricted Stock Awards and the 83(b) Election

Restricted stock awards work differently. Your employer transfers actual shares to you on the grant date, but they’re subject to forfeiture if you leave before vesting. Under the default rules of Section 83, you don’t owe tax until the forfeiture risk lifts. At that point, the full market value is ordinary income, just as with RSUs.⁴

Restricted stock awards come with an option RSUs don’t have: the Section 83(b) election. Filing it lets you pay ordinary income tax on the shares’ value at the grant date instead of waiting for vesting. If the stock is worth $2 per share at grant and $40 per share three years later at vesting, the difference between paying tax on $2 versus $40 is enormous.⁴

Electing early also converts all appreciation from the grant date forward into capital gain rather than ordinary income, and your long-term holding period starts on the grant date.

The election must be filed with the IRS within 30 days of the transfer date. Miss that deadline by a day and you lose the opportunity permanently; the election cannot be revoked once filed.⁵ A copy should also go to your employer.

The risk: if you file an 83(b) election and then forfeit the shares before vesting, you get no deduction for the income tax already paid. The election makes the most sense when the grant-date value is low, the stock has strong growth potential, and you’re reasonably confident you’ll stay through vesting.

Non-Qualified Stock Options (NSOs)

An NSO gives you the right to buy company shares at a fixed strike price set on the grant date. Unlike RSUs, nothing happens at grant and nothing happens at vesting. The first tax event arrives when you exercise the option and buy the shares.⁶

At exercise, the ordinary income you owe equals the market value of the shares on the exercise date minus the strike price. If your strike price is $10 and the stock is trading at $30 when you exercise, that $20 per-share spread is ordinary income reported on your W-2 and subject to income tax withholding and payroll taxes.⁶

Most employees don’t have cash for both the strike price and the tax, so companies commonly offer sell-to-cover or cashless exercise. Sell-to-cover exercises all your options and sells just enough shares to pay the strike price and withholding, leaving you the rest. A full same-day sale exercises and sells everything at once.

If you hold shares after exercise, your cost basis is the market value on the exercise date (strike price plus the ordinary income already recognized). In the example above, that’s $30 per share. Any further gain or loss above $30 is capital gain or loss, with the holding period starting on the exercise date.¹ Hold more than a year to get long-term rates.

Incentive Stock Options (ISOs)

ISOs look like NSOs on the surface but carry a significant advantage: no ordinary income tax at exercise for regular tax purposes. If you meet the holding requirements, the entire spread from strike price to sale price can qualify as long-term capital gain.⁷

Qualifying vs. Disqualifying Dispositions

To get the full capital gains treatment, you must hold the shares at least two years after the grant date and at least one year after the exercise date. A sale that meets both is a qualifying disposition. The entire gain above your strike price is long-term capital gain, and nothing shows up on your W-2.⁷

Sell before meeting either holding requirement and you have a disqualifying disposition. The spread between the strike price and the market value at exercise (or the sale price, if lower) becomes ordinary income, taxed just like NSO income. Any remaining gain above the exercise-date market value is capital gain, short- or long-term depending on how long you held the shares after exercise.⁷

The AMT Trap

Here’s where ISOs get complicated. Even though no ordinary income tax is due at exercise, the spread is a preference item for the Alternative Minimum Tax. AMT is a parallel calculation that adds back certain items to ensure higher-income taxpayers pay a minimum. The ISO spread can push your AMT liability above your regular tax, creating a real bill in the exercise year even though you haven’t sold anything.⁸

AMT paid because of ISOs generates a minimum tax credit you can carry forward indefinitely. In future years where your regular tax exceeds your AMT, the credit offsets your regular tax bill. But if you keep exercising large batches of ISOs every year, you may stay in AMT territory and never use the credit.

The $100,000 Limit

If more than $100,000 worth of ISOs (measured at grant-date value) become exercisable for the first time in any calendar year, the excess is automatically reclassified as NSOs. Earlier grants keep ISO treatment and later grants lose it.⁹

Employee Stock Purchase Plans (ESPPs)

Qualified ESPPs let you buy company stock at a discount, often 15% below market price, through payroll deductions. The discount and any additional appreciation create taxable income, but the timing depends on how long you hold the shares.¹⁰

For a qualifying disposition, you must hold the shares more than two years from the offering date and more than one year from the purchase date. The ordinary income portion is the lesser of the actual discount at purchase or the gain on the sale, and everything above that is long-term capital gain.¹¹

Sell before meeting both holding periods and it’s a disqualifying disposition. The full discount between the purchase-date market value and the price you paid becomes ordinary income, regardless of whether you sold at a gain or a loss. Any additional gain above the purchase-date market value is capital gain.¹¹

Many ESPPs include a lookback that sets the purchase price based on the lower of the stock price at the beginning or end of the offering period, amplifying the discount. ESPP purchases are capped at $25,000 worth of stock per calendar year, measured at the offering-date price.¹⁰

The 3.8% Net Investment Income Tax

Capital gains from selling stock grant shares can trigger an extra 3.8% surtax that catches employees off guard. The net investment income tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds $200,000 for single filers ($250,000 married filing jointly, $125,000 married filing separately).¹²

Net investment income includes capital gains, dividends, and interest. Wages are not included, so the ordinary income from RSU vesting or NSO exercise isn’t directly hit. But that W-2 income does count toward your MAGI, which determines whether the surtax kicks in. A large vesting event can push your MAGI over the threshold and trigger the 3.8% tax on investment income you’d otherwise keep.¹³

Wash Sales Triggered by Vesting

The wash sale rule disallows a loss on a stock sale if you buy substantially identical shares within 30 days before or after the sale.¹⁴ RSU vesting counts as acquiring shares. If you sell company stock at a loss and an RSU vesting delivers new shares of the same company within that 61-day window, the IRS disallows your loss.

The disallowed loss isn’t gone forever; it gets added to the basis of the newly acquired shares and reduces your gain when you eventually sell those. But if you were counting on the loss to offset other current-year gains, you’re out of luck. Employees on quarterly or monthly vesting schedules should watch the calendar carefully before harvesting losses.

The Cost Basis Mistake That Causes Double Taxation

The ordinary income from RSUs, restricted stock awards without an 83(b) election, and NSOs shows up in Box 1 of your W-2. ISO exercises under a qualifying disposition do not generate W-2 income for regular tax purposes, though your employer will issue a Form 3921 with the exercise details for AMT calculations.

When you sell shares, your brokerage sends a Form 1099-B reporting proceeds and cost basis. For stock compensation, the basis on this form is frequently wrong. Brokerages are required to report basis for options granted after 2013, but that basis often omits the ordinary income you already recognized at vesting or exercise.¹⁵

If you don’t correct this, you pay tax twice on the same income: once as W-2 wages and again as a capital gain. To fix it, report the 1099-B basis in column (e) of Form 8949 and enter an adjustment in column (g) to reflect the income already taxed. For RSUs, the correct basis is the market value on the vesting date. For NSOs, it’s the market value on the exercise date. This is the single most common tax mistake with stock compensation.¹⁵

A large NSO exercise, ISO disqualifying disposition, or stock sale can also create a tax liability that isn’t covered by regular paycheck withholding. If the gap is significant, make estimated tax payments during the year using Form 1040-ES to avoid underpayment penalties.¹⁶ Run the numbers after any major vesting or exercise event rather than waiting until you file.

1
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
2
Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates
3
Internal Revenue Service. Publication 15-T (2026), Federal Income Tax Withholding Methods
4
Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
5
Internal Revenue Service. Instructions for Form 15620 Section 83(b) Election
6
Internal Revenue Service. Topic No. 427, Stock Options
7
Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options
8
Office of the Law Revision Counsel. 26 USC 56 – Adjustments in Computing Alternative Minimum Taxable Income
9
eCFR. 26 CFR 1.422-4 – $100,000 Limitation for Incentive Stock Options
10
Office of the Law Revision Counsel. 26 USC 423 – Employee Stock Purchase Plans
11
Internal Revenue Service. Stocks (Options, Splits, Traders) 5
12
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
13
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
14
eCFR. 26 CFR 1.1091-1 – Losses From Wash Sales of Stock or Securities
15
Internal Revenue Service. Instructions for Form 8949
16
Internal Revenue Service. Form 1040-ES – Estimated Tax for Individuals