Vested equity is the portion of company stock or options you fully own because you’ve met the conditions your employer attached to the grant, most often a requirement that you stay at the company for a set number of years. Until those conditions are satisfied, the equity is a promise the company can take back if you leave. Once vested, it’s yours, whether you quit, get laid off, or are fired.
Everything else about equity compensation, the schedules, the tax rules, the deadlines when you leave, flows from that one distinction between a conditional promise and genuine ownership.
How Vesting Schedules Work
Your grant agreement includes a vesting schedule: the timeline that dictates when your equity converts from unvested to vested. Most schedules are time-based, meaning the only condition is that you keep working at the company for a specified duration.
The most common arrangement in technology is a four-year schedule with a one-year cliff. Nothing vests during your first twelve months. Leave before your one-year anniversary and you walk away with zero equity from that grant. Hit the one-year mark and 25% vests at once. The remaining 75% typically vests in equal monthly or quarterly installments over the next three years, often 1/48th of the grant each month.
Not all vesting is purely time-based. Performance-based schedules tie vesting to hitting specific targets, such as revenue milestones, product launches, or individual metrics, and are more common in executive packages. A separate variation called double-trigger vesting requires two conditions at once, typically a change of control combined with a continued service requirement.
Types of Equity That Vest
Equity compensation takes several forms. Each has different mechanics for how ownership transfers to you and when the tax bill lands.
Restricted Stock Units
Restricted Stock Units (RSUs) are a promise to deliver actual shares at a future date. You own nothing until the vesting date arrives. When an RSU vests, the company deposits shares into your brokerage account, and the fair market value on that date counts as ordinary income. Under federal tax law, property received for services is taxable when it’s no longer subject to a risk of forfeiture, which for RSUs means the vesting date.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
RSUs are popular at large public companies because they’re straightforward. You pay nothing to receive the shares, and their value tracks the stock price. The downside is that you have no control over timing. You owe income tax when the shares vest whether or not you sell them.
Stock Options: ISOs and NSOs
Stock options give you the right to buy shares at a fixed price, called the exercise price or strike price, usually set at the stock’s fair market value on the grant date. If the stock rises above the strike price, the difference is your profit. If it never does, the options are worthless whether they’ve vested or not.
Options come in two flavors. Incentive Stock Options (ISOs) are available only to employees and carry preferential tax treatment. You generally owe no regular income tax when you vest or exercise them. Non-Qualified Stock Options (NSOs) can be granted to employees, contractors, or directors, but the spread between the stock price and the exercise price is taxed as ordinary income the moment you exercise.2Internal Revenue Service. Topic No. 427, Stock Options
One important limit on ISOs: if the total fair market value of stock covered by ISOs that become exercisable for the first time in any calendar year exceeds $100,000, the excess is automatically treated as NSOs. The $100,000 is measured by the stock’s value at the time each option was granted, and options are counted in the order granted.3Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options
Restricted Stock Awards and the 83(b) Election
Restricted Stock Awards (RSAs) differ from RSUs in a fundamental way. You receive actual shares immediately, often at a very low price. The company retains the right to buy those shares back at your purchase price if you leave before they vest. As each tranche vests, the repurchase right drops away and you own those shares free and clear.
RSAs open the door to a powerful tax strategy called the Section 83(b) election. By filing this election, you choose to pay ordinary income tax on the shares’ value at the time of the grant, before they appreciate, rather than paying tax on the higher value at each vesting date. If the stock climbs substantially, this front-loads a small tax bill and converts all future appreciation into capital gains, which are taxed at lower rates.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
The catch is a strict deadline. You must file the 83(b) election within 30 days of receiving the shares. There are no extensions and no exceptions. If the 30th day falls on a weekend or federal holiday, the deadline shifts to the next business day. That’s the only flexibility.4Internal Revenue Service. Instructions for Form 15620, Section 83(b) Election Miss the deadline and you’ll be taxed on the full fair market value at each vesting date, exactly the outcome the election was designed to avoid. The other risk: if you leave before vesting and the company repurchases your unvested shares, you don’t get a refund on the taxes you already paid.
How Vested Equity Is Taxed
Tax obligations depend heavily on the type of equity you hold and when you act. Getting the timing wrong can cost tens of thousands of dollars on a single grant.
RSUs
When RSUs vest, the full fair market value of the delivered shares is treated as ordinary income for the year. Your employer withholds federal income tax, Social Security, and Medicare, typically by selling a portion of the shares before depositing the rest in your account. The income and withholding appear on your W-2. Your cost basis in the shares is the fair market value on the vesting date, so if you sell immediately, you’ll have little or no additional gain or loss.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services
NSOs
Vesting an NSO doesn’t trigger a tax bill by itself. The taxable event happens when you exercise, that is, when you pay the strike price to buy the shares. The spread between the stock’s market value at exercise and the strike price is taxed as ordinary income, and your employer withholds income tax, Social Security, and Medicare from it.2Internal Revenue Service. Topic No. 427, Stock Options Your cost basis in the shares becomes the market value at exercise, and any gain or loss when you eventually sell is a capital gain or loss.
ISOs and the AMT Trap
ISOs get more favorable treatment. You generally owe no regular federal income tax when you exercise them. But there’s a significant complication. The spread at exercise counts as an adjustment for the Alternative Minimum Tax, and exercising a large block of ISOs in a single year can trigger a separate AMT liability that catches many employees off guard.2Internal Revenue Service. Topic No. 427, Stock Options Running the numbers through a tax projection before exercising is the only way to avoid a surprise bill.
To keep the preferential ISO treatment, you must hold the shares for at least two years from the grant date and at least one year from the exercise date. Selling before either holding period expires is a disqualifying disposition, and it forces the spread to be taxed as ordinary income, the same as if the options had been NSOs all along.3Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options This is where most people trip up. They exercise, the stock runs up, and they sell before checking whether the holding periods have been met.
Capital Gains at Sale
Once you own shares, whether from RSUs, exercised options, or RSAs, any gain between your cost basis and the sale price is a capital gain. If you held for more than one year after the taxable event that established your basis, the gain qualifies for the long-term capital gains rate, which is significantly lower than ordinary income rates for most people.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses High earners may also owe the 3.8% net investment income tax on top. If you hold for one year or less, the gain is short-term and taxed at your ordinary income rate.
What Happens to Your Equity When You Leave
The rules for your equity diverge sharply depending on whether it has vested when you walk out the door.
Unvested Equity Is Forfeited
Unvested shares and options are almost always forfeited immediately upon termination, regardless of the reason you’re leaving. This is the core retention mechanism of vesting. If you resign or get laid off two years into a four-year schedule, you keep what has vested to that point and lose the rest. There’s generally no compensation owed for the unvested portion.
Vested Shares Are Yours
Vested RSUs and RSAs are your property. The shares sit in your brokerage account and your former employer has no claim to them. If the company is publicly traded, you can sell on the open market, subject to any insider trading restrictions that may still apply during a post-employment cooling-off period.
Vested Options Expire on a Deadline
Vested stock options require you to act quickly after leaving. Your grant agreement will specify a post-termination exercise period, the window during which you can exercise your vested options by paying the strike price. A majority of companies set this at 90 days, though some tie the length to tenure or offer extended windows. If you don’t exercise within that window, your vested options expire worthless, even if they were deep in the money.
For ISOs, the deadline carries an extra sting. To preserve ISO tax treatment, you must exercise within three months of your last day of employment. Wait longer and the options automatically convert to NSOs, which means the spread at exercise gets taxed as ordinary income with full payroll tax withholding. If you’re disabled within the meaning of the tax code, that three-month window extends to one year.3Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options Either way, exercising vested options after departure often requires coming up with cash to pay the strike price, potentially a large amount, within a tight timeframe. This is the most financially dangerous deadline in equity compensation and the one departing employees are most likely to miss.
Private Company Shares Come With Strings
Owning vested shares in a private company is not the same as owning shares you can sell. Private company stock almost always comes with transfer restrictions written into the stockholders’ agreement or the original purchase agreement. The most common is a right of first refusal, which requires you to offer your shares to the company or existing shareholders before selling to anyone else, on the same terms the outside buyer offered. Many private companies also require board approval for any stock transfer, and some outright prohibit sales until a liquidity event like an IPO or acquisition. Your vested equity might be valuable on paper but illiquid for years.
If Your Company Is Acquired
Vesting can also change when the company changes hands. What happens depends on the acceleration provisions in your grant agreement. Single-trigger acceleration vests some or all of your unvested equity the moment the acquisition closes, with no additional condition. Double-trigger acceleration requires two events: the company must be sold, and you must then be terminated without cause or resign for good reason, meaning a significant pay cut, forced relocation, or major downgrade in responsibilities. Most double-trigger agreements require the termination to occur within 9 to 18 months after the deal closes.
If your agreement has no acceleration provision, the acquirer typically either assumes your unvested equity, converting it to equivalent equity in the new company on the same vesting schedule, or cancels it outright, sometimes with a cash payout. When you’re negotiating an offer with equity, this is the clause worth spending time on.