An equity award is company stock, or the right to receive company stock later, given to you as part of your pay. Most equity awards come with a vesting schedule that controls when you actually own the shares, and the tax you owe depends heavily on which type of award you hold and when you take action on it. The value moves with the share price, so the award pays off when the company does well and gives you a reason to stay.
Vesting Comes First
Everything starts on the grant date, the day the company formally approves your award and locks in its key terms. One of those terms is the fair market value of the stock on that date, usually the closing price. That grant-date value is the baseline for later tax math.
You don’t own anything yet on the grant date. Ownership depends on satisfying a vesting schedule, and schedules come in two shapes. Under cliff vesting, nothing vests until a set date (usually one year), and then a chunk vests all at once; leave before the cliff and you walk away with nothing. Under graded vesting, shares vest in smaller increments over time, a typical setup being a one-year cliff followed by monthly or quarterly vesting over the next three years, so 25% vests at the cliff and the rest trickles in through year four.
If you leave before shares vest, those unvested shares are forfeited. You lose all rights to them and they return to the company’s equity pool. Forfeiture is the stick that makes vesting work as a retention tool.
The Main Types of Equity Awards
Restricted Stock Units
Restricted stock units are the most common form of equity compensation at public companies. An RSU is a promise: if you stay long enough to satisfy the vesting schedule, the company will deliver actual shares (or, less commonly, a cash equivalent) on the vesting date. Until then, you don’t own any stock, you can’t vote it, and you receive no dividends, though some plans pay dividend equivalents when your RSUs vest.
Because RSUs are just a promise until they vest, there’s nothing to buy and no upfront cost. Shares appear in your brokerage account on each vesting date, and the company withholds a portion to cover taxes.
RSUs are taxed when they vest and shares are delivered. The full fair market value of the delivered shares counts as ordinary income, just like wages. Your employer reports the amount on your W-2 and typically withholds shares or cash to cover federal and state income taxes plus Social Security and Medicare.1Internal Revenue Service. Publication 15-A (2026) Employers Supplemental Tax Guide The federal supplemental withholding rate is 22% on the first $1 million of supplemental wages and 37% above that. The flat 22% often undertaxes people in higher brackets, so many RSU recipients owe more when they file. Your cost basis in the shares equals the fair market value on the vesting date.
Restricted Stock Awards
A restricted stock award works differently. You receive actual shares on the grant date, but they come with restrictions, mainly that you forfeit them if you leave before vesting. Because you legally own the stock from day one, you can vote those shares and collect dividends during the vesting period.
RSAs are more common at startups and early-stage companies, where the stock price is low and the potential upside is large. Under the general rule of federal tax law, property received for services is taxed when it’s no longer subject to a substantial risk of forfeiture, meaning at vesting.2Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection With Performance of Services For RSA holders, that means ordinary income tax on the full value of the shares when they vest, which can be a much higher number than on the grant date.
Non-Qualified Stock Options
A stock option gives you the right to buy company shares at a fixed strike price, almost always set at the stock’s fair market value on the grant date. If the price rises above your strike, the difference (the spread) is your profit. If it stays flat or falls, the option is underwater.
Non-qualified stock options are the more flexible variety. They can be granted to employees, contractors, directors, and consultants, and there’s no special limit on their value. The trade-off is straightforward taxation: when you exercise an NSO, the spread is taxed as ordinary income immediately. Your employer withholds income tax and Social Security and Medicare, and the income shows up on your W-2. Non-employees receive a 1099-NEC instead.
Your cost basis in the shares becomes the strike price plus the ordinary income recognized at exercise. Sell within a year of exercise and any further gain is a short-term capital gain taxed at ordinary rates. Hold longer than a year and it qualifies for the lower long-term capital gains rate.3Internal Revenue Service. Topic No. 409 Capital Gains and Losses
Incentive Stock Options
Incentive stock options are available only to employees and must meet several federal requirements. The strike price can’t be less than fair market value on the grant date, the option can’t be exercisable more than ten years after grant, and the option can’t be transferred during your lifetime. ISOs also carry a cap: only $100,000 worth of options, measured by fair market value on the grant date, can first become exercisable as ISOs in any single calendar year. Anything above that threshold is automatically reclassified as an NSO and taxed accordingly.4Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options
The payoff is preferential tax treatment. Hold the shares at least two years from the grant date and one year from the exercise date, and the entire gain is taxed at long-term capital gains rates.5eCFR. 26 CFR 1.422-1 – Incentive Stock Options General Rules There’s no ordinary income tax when you exercise an ISO, and nothing is reported on your W-2 at exercise.
Performance Stock Units
Performance stock units look like RSUs but add a performance condition on top of the time-based schedule. Instead of vesting automatically, PSUs vest only if the company hits specific targets such as revenue growth, earnings per share, or total shareholder return. Miss the minimum threshold and no shares are delivered. Hit the target and you receive the stated number of shares. Exceed it and many plans pay out more, sometimes up to 200% of the target grant.
The tax treatment mirrors RSUs: value delivered is taxed as ordinary income at vesting, and later gain or loss on sale is capital. PSUs are typically reserved for senior leaders.
The 83(b) Election for RSA Holders
The Section 83(b) election is the most consequential tax decision an RSA holder makes. By filing this election with the IRS within 30 days of receiving the shares, you choose to pay ordinary income tax immediately on the stock’s current value, which at a startup might be pennies per share. If the stock later appreciates, all of that growth is taxed at capital gains rates instead of ordinary income rates when you eventually sell.2Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection With Performance of Services
The risk is real. If the stock drops after you file, or if you leave and forfeit the shares, you’ve paid tax on value you never received. There’s no refund and no deduction for the forfeited shares. The 30-day deadline is absolute. Miss it by one day and the election is gone forever for that grant. Most people who know about the 83(b) election and still get burned simply forget to file on time.
ISOs and the AMT Trap
The catch with ISOs is the alternative minimum tax. When you exercise, the spread is an adjustment for AMT purposes, added back to your income under the AMT calculation even though it isn’t taxed under the regular system.6Office of the Law Revision Counsel. 26 U.S. Code 56 – Adjustments in Computing Alternative Minimum Taxable Income For 2026, the AMT exemption is $90,100 for single filers and $140,200 for married couples filing jointly. If your AMT income exceeds those thresholds, you may owe AMT on the exercise spread, paying tax on paper gains before selling a single share.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Sell ISO shares before meeting both holding periods and the sale is a disqualifying disposition. The spread at exercise (or the actual gain, whichever is smaller) gets reclassified as ordinary income, and you lose the capital gains benefit. Exercising a large ISO grant and then holding through a stock decline can leave you owing AMT on gains that no longer exist, a scenario that financially devastated many employees during the dot-com crash and still catches people off guard.
Exercising Your Options
RSUs and RSAs require no action from you. Stock options do. You have to decide when to exercise and how to pay for the shares.
- Cash exercise: you pay the full strike price out of pocket and receive the shares. This preserves all your shares but requires cash upfront.
- Sell-to-cover: you exercise and immediately sell enough shares to cover the strike price and tax withholding, keeping the rest. This is the most popular method at public companies because it needs no cash out of pocket.
- Net exercise: the company withholds a portion of the shares to cover the exercise cost and taxes, delivering only the net shares to you. No cash changes hands and no shares hit the open market, but you end up with fewer shares than a cash exercise would produce.
At public companies, sell-to-cover and net exercise are standard. At private companies your choices may be limited, since there’s no public market to sell into and net exercise has to be offered by the employer.
Selling the Shares
Regardless of award type, selling creates a capital gain or loss: sale price minus cost basis. Short-term gains on shares held one year or less are taxed at your regular income rate. Long-term gains on shares held more than one year use the 2026 federal rates of 0%, 15%, or 20% depending on income.3Internal Revenue Service. Topic No. 409 Capital Gains and Losses
High earners face an additional 3.8% net investment income tax on capital gains when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.8Internal Revenue Service. Net Investment Income Tax Between federal income tax, state income tax, and the net investment income tax, selling appreciated equity compensation shares without planning can push a total tax rate close to 50% in high-tax states.
What Happens When You Leave
Unvested RSUs and RSAs are almost always forfeited immediately when you leave, whether you quit, are laid off, or are fired. Some agreements include exceptions for termination without cause or for retirement, but the default is forfeiture. The specifics live in your grant agreement, not in any general rule.
Vested but unexercised stock options get a limited window after your last day. For ISOs, the federal tax code requires exercise within 90 days of termination for the options to keep their ISO tax treatment. If your company offers a longer post-termination exercise window, any exercise after day 90 converts those ISOs into NSOs, meaning the spread is taxed as ordinary income at exercise.4Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options
For NSOs, the post-termination window is governed entirely by your grant agreement. Common windows run from 30 to 90 days, though some companies offer longer. Miss the window and your vested options expire worthless. If you’re leaving a job with vested in-the-money options, mark the exercise deadline on your calendar the day you give notice.
Vesting Acceleration in an Acquisition
When your company is acquired, your equity doesn’t just continue as normal. What happens depends on the acceleration provisions in your grant agreement or the company’s equity plan. Two structures dominate.
Under single-trigger acceleration, all or part of your unvested equity vests immediately when the acquisition closes. You don’t need to be terminated; the deal itself is the trigger. This is employee-friendly but less common, because acquirers dislike it. Under double-trigger acceleration, vesting speeds up only if two events both happen, typically the acquisition closes and you are involuntarily terminated (or forced to resign due to a pay cut, relocation, or significant demotion) within 9 to 18 months after closing. This is the more common structure because it protects employees who are pushed out post-acquisition without giving a windfall to those who stay on happily.
Some double-trigger agreements include a short pre-closing window, usually three months or less, to prevent the company from firing you right before the deal closes to avoid triggering acceleration. If your equity is a meaningful part of your compensation, read the acceleration clause in your plan documents before any rumored acquisition, not after.
At private companies that haven’t yet gone public, RSUs sometimes use a double-trigger structure by default: the first trigger is your time-based vesting schedule, and the second is a liquidity event like an IPO or acquisition. Until both pull, no shares are delivered and no tax is owed, which means you can work at a private company for years with fully time-vested RSUs and still not receive any shares until the company goes public or is sold.