The core difference in RSU vs ISO tax treatment comes down to timing and character: Restricted Stock Units are taxed as ordinary wage income the moment they vest, with federal, Social Security, and Medicare tax withheld automatically, while Incentive Stock Options trigger no regular income tax when you exercise them and can convert your entire gain into long-term capital gains if you hold the shares long enough. The catch with ISOs is the Alternative Minimum Tax, which can hit you at exercise even though you haven’t sold a single share.
How RSUs Get Taxed
An RSU is a company’s promise to deliver shares once you satisfy a vesting schedule. The grant itself is not a taxable event. You don’t own anything yet.
The tax bill arrives at vesting. On that date, the full fair market value of the shares delivered counts as ordinary income, exactly like wages. It lands on your W-2, and your employer withholds federal income tax, Social Security tax (up to the $184,500 wage base in 2026), and Medicare tax.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services2Social Security Administration. Contribution and Benefit Base Most employers handle this through “net settlement” or “sell to cover,” keeping back a portion of the vesting shares to pay the tax.
Watch the withholding rate. The federal supplemental wage rate is 22% on amounts up to $1 million, which is often well below the actual marginal rate of someone receiving meaningful equity. That gap can leave you owing more when you file, and high-tax states widen the shortfall.
Your cost basis in the shares equals the fair market value on the vesting date. Any price movement after that is a capital gain or loss when you sell.
Private-Company RSUs Vest on Two Triggers
Startup and private-company RSUs usually carry two vesting conditions. The first is the time-based schedule. The second is a liquidity event such as an IPO or acquisition. Both must occur before shares settle, income appears on your W-2, and taxes come due. The design exists so you aren’t stuck with a tax bill on illiquid stock you can’t sell.
Many private-company agreements also include a “must be present to win” clause. If the liquidity trigger fires after you leave, you forfeit the shares.
The 83(b) Election Does Not Apply to Standard RSUs
The Section 83(b) election lets holders of restricted stock awards (RSAs) pay ordinary income tax on the grant-date value instead of the vesting-date value.3Internal Revenue Service. Form 15620 – Section 83(b) Election It does not apply to standard RSUs, because an RSU is a promise rather than transferred property, and 83(b) requires a transfer of property.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services If someone tells you to file an 83(b) for your “RSUs,” confirm you actually hold RSAs.
How ISOs Get Taxed
An ISO gives you the right to buy company shares at a locked strike price, set at fair market value on the grant date. The grant is not taxable. The options vest on a schedule, and you decide when to exercise by paying the strike price out of pocket.
Exercising ISOs does not trigger regular federal income tax or payroll tax. The spread between the current fair market value and your strike price does not appear on your W-2 and is not subject to Social Security or Medicare tax.4Office of the Law Revision Counsel. 26 USC 421 – General Rules for Certain Stock Options That deferral is the whole appeal.
The AMT Problem at Exercise
The exercise spread is invisible for regular tax but shows up as an adjustment item for the Alternative Minimum Tax, reported on Form 6251.5Office of the Law Revision Counsel. 26 USC 56 – Adjustments in Computing Alternative Minimum Taxable Income6Internal Revenue Service. Instructions for Form 6251 AMT is a parallel calculation that adds back preference items and applies its own exemption.
For 2026, the exemption is $90,100 for single filers and $140,200 for joint filers, phasing out beginning at $500,000 and $1,000,000 respectively.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Alternative minimum taxable income above the exemption is taxed at 26% on the first $244,500 and 28% above that.8Office of the Law Revision Counsel. 26 USC 55 – Alternative Minimum Tax Imposed
The practical problem: this tax is owed in cash even though you haven’t sold anything. You paid the strike price, you’re now holding shares (often illiquid, often within a mandatory holding period), and the IRS wants a check. A large single-year exercise with a big spread can generate an AMT bill in the tens of thousands with no shares sold to fund it.
The AMT Credit Comes Back Later
AMT paid because of ISO exercises creates a minimum tax credit that carries forward. In any later year where your regular tax exceeds your tentative minimum tax, you can apply the credit to reduce what you owe.9Office of the Law Revision Counsel. 26 USC 53 – Credit for Prior Year Minimum Tax Liability The credit doesn’t expire. But recovering it can take years, and in the meantime the money is with the government, not you.
The $100,000 Annual ISO Limit
Federal law caps the value of ISOs that can first become exercisable in any calendar year at $100,000 per employee, measured by grant-date fair market value.10Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options Options above that threshold are automatically reclassified as non-qualified stock options (NSOs). NSO spreads at exercise are ordinary income subject to payroll taxes, with no AMT-only treatment. Companies rarely flag this reclassification, so if you hold a large grant, run the calculation yourself before exercising.
What Happens When You Sell
Selling shares always produces a capital gain or loss. What differs is how the basis is set and, for ISOs, whether you cleared the two holding-period tests.
Selling RSU Shares
Your basis is the fair market value on the vesting date, the same amount already taxed as ordinary income. Hold more than a year after vesting and the gain is long-term, taxed at 0%, 15%, or 20% depending on income. Sell within a year and it’s short-term at ordinary rates.11Internal Revenue Service. Topic No. 409, Capital Gains and Losses The sale is reported to you on Form 1099-B.12Internal Revenue Service. About Form 1099-B, Proceeds From Broker and Barter Exchange Transactions
Selling immediately at vesting usually produces little or no capital gain, because the sale price and vesting-date basis are nearly identical. If the price drops below the vesting-day value while you hold, you have a capital loss available to offset other gains.
Selling ISO Shares: Qualifying and Disqualifying Dispositions
ISO sales have two clocks. You must hold the shares at least two years from the grant date and at least one year from the exercise date. Both must run before you sell.10Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options
Meet both, and the sale is a qualifying disposition. Your basis is the strike price, and the entire gain from strike price to sale price is long-term capital gain.11Internal Revenue Service. Topic No. 409, Capital Gains and Losses This is the outcome ISOs are designed to produce.
Sell before either clock runs out and you have a disqualifying disposition. The ordinary income portion equals the lesser of the spread at exercise or the actual gain on the sale, reclassified as wages on your W-2. Anything above that is capital gain, long- or short-term depending on how long you held the shares after exercise.4Office of the Law Revision Counsel. 26 USC 421 – General Rules for Certain Stock Options
Your employer files Form 3921 documenting the grant date, exercise date, strike price, and fair market value at exercise. Keep the copy you receive; you’ll need it for both the AMT calculation and the eventual sale.13Internal Revenue Service. Instructions for Forms 3921 and 3922
Side-by-Side Comparison
- Tax at grant: neither RSUs nor ISOs create a tax event.
- Tax at vesting or exercise: RSUs are ordinary income at vesting with automatic withholding; ISOs owe no regular tax at exercise, but the spread is an AMT adjustment.
- Payroll taxes: RSU vesting income is subject to Social Security and Medicare; the ISO spread at exercise is not.
- Cash out of pocket: RSUs require nothing from you; ISOs require you to pay the strike price and possibly cover AMT in cash.
- Capital gains reach: RSU holders get long-term rates only on appreciation after vesting; ISO holders who meet both holding periods get long-term rates on everything above the strike price.
- Downside: vested RSU shares retain value unless the stock reaches zero; ISOs are worthless whenever the market price is below the strike price.
- Complexity: RSU tax is one automatic event; ISO tax involves AMT, dual holding periods, the credit carryforward, and the risk of a disqualifying disposition.
Choosing Between Them
ISOs pay off when you have strong conviction in the stock, cash on hand to cover the strike price and any AMT, and the willingness to hold through both required periods. Convert the whole gain to long-term capital gains and the tax savings against ordinary-income treatment can be substantial. The costs are equally real: capital tied up, AMT exposure, and concentration in a single stock with no guaranteed outcome.
RSUs fit when you want predictable value delivery with no decisions and no cash outlay. Withholding happens automatically, and selling at vesting eliminates concentration risk. The price is that every dollar first passes through ordinary income rates, with capital gains treatment available only on post-vesting appreciation.
If you hold both, watch the interaction. Exercising ISOs in the same year a large RSU tranche vests can push combined income into AMT territory you didn’t plan for. Running Form 6251 numbers before year-end, not after, is worth more than almost any other equity-comp move.
Watch Out for Wash Sales
Selling company stock at a loss while acquiring substantially identical shares within 30 days before or after the sale triggers the wash sale rule, and the IRS disallows the loss.14eCFR. 26 CFR 1.1091-1 – Losses From Wash Sales of Stock or Securities The disallowed amount shifts into the basis of the replacement shares, so it isn’t gone forever, just deferred.
RSU vesting counts as an acquisition. So does an ISO exercise. If you sell older company shares at a loss and new RSUs vest within the 30-day window, you’ve triggered a wash sale whether you intended to or not. Selling RSU shares at vesting rather than accumulating older lots is one way to reduce the risk.