A cashless exercise of stock options and RSUs lets you convert equity compensation into shares or cash without paying anything out of pocket: the broker sells just enough of your shares at the current market price to cover the strike price (for options) and the tax withholding, then delivers the rest to your account. It is the default route most employees take, and it works. The tax reporting is where people get hurt, especially on cost basis.
How the Mechanics Actually Work
For nonqualified stock options, three things happen almost at once. You tell the broker to exercise, the broker sells enough of the resulting shares on the open market, and the proceeds pay the strike price, the mandatory withholding on the spread, and any commissions. The leftover shares land in your brokerage account. Your holding period on those net shares begins the day after exercise.
RSUs work differently because there is no strike price. When the units vest, the company simply delivers shares, and the full market value of each share becomes taxable compensation. The “cashless” piece here is really a sell-to-cover: the broker withholds a portion of the vesting shares, sells them, and sends the cash to cover your income and payroll tax obligation. The remaining shares are deposited into your account with a cost basis equal to the fair market value on the vesting date.
What You Owe in Tax at Exercise or Vesting
Either transaction triggers ordinary income immediately. For nonqualified options, the taxable amount is the spread: market price minus strike price, times the number of shares exercised. For RSUs, it is the full market value of every share that vests. Both amounts land on your W-2 as wages. Nonqualified option income appears in Box 12 under Code V.1Internal Revenue Service. Announcement 2002-108 RSU income has no dedicated code; it is folded into Box 1 and into your Social Security and Medicare wages in Boxes 3 and 5. Some employers label it in Box 14 for clarity, but they are not required to.
The income is subject to federal and state income tax, Social Security tax up to the annual wage base, and Medicare tax. The federal supplemental withholding rate is a flat 22% on compensation up to $1 million, and 37% on anything above that threshold within the same calendar year.2Internal Revenue Service. Publication 15 – Employer’s Tax Guide Your employer also withholds Social Security tax (6.2%) on income up to the $184,500 wage base for 2026, plus Medicare tax (1.45%) with no cap.3Social Security Administration. Contribution and Benefit Base
Extra Taxes High Earners Should Expect
A big exercise or vest can push you into territory where additional taxes apply. The Additional Medicare Tax adds 0.9% on wages above $200,000 for single filers or $250,000 for joint filers.4Internal Revenue Service. Topic No. 560, Additional Medicare Tax Your employer withholds it once your total wages for the year cross $200,000, regardless of filing status, which can create either over- or under-withholding depending on your household situation.
The Net Investment Income Tax is a separate 3.8% surtax on investment income once modified AGI crosses $200,000 single or $250,000 joint.5Internal Revenue Service. Net Investment Income Tax Compensation income from your options or RSUs is not itself net investment income, but it inflates your AGI and can pull capital gains from your other investments into the NIIT zone.
Why a Cashless Exercise Is Risky for ISOs
If your options are incentive stock options rather than nonqualified options, a cashless exercise undoes the main reason to hold ISOs in the first place. The favorable tax treatment requires holding the shares at least two years after the grant date and one year after the exercise date.6Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options A same-day cashless exercise violates both periods, because you are selling on the day you acquire.
That makes the sale a disqualifying disposition. The spread between strike price and market price on the exercise date gets taxed as ordinary income, just like a nonqualified option. You lose the capital gains advantage entirely. For ISOs, the cashless route often makes less sense than paying cash to exercise and holding the shares long enough to qualify. Note the separate risk if you do go that route: exercising ISOs and holding adds the spread to income for Alternative Minimum Tax purposes even though you have not sold anything, which can produce a sizable AMT bill in the exercise year.
Your employer must file Form 3921 for every ISO exercise, reporting the grant date, exercise date, exercise price, and fair market value.7Internal Revenue Service. About Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) Keep that form; you will use it to figure out whether you triggered a disqualifying disposition and how to report the income.
The Cost Basis Trap on Your 1099-B
This is where most people overpay, sometimes dramatically. When the broker reports the sale on Form 1099-B, IRS rules prohibit including the compensation income you already recognized as part of the cost basis.8Internal Revenue Service. About Form 1099-B, Proceeds from Broker and Barter Exchange Transactions For nonqualified options, the 1099-B shows your basis as only the strike price, not the full market value at exercise. For RSUs, the basis may be reported as zero or omitted entirely, because RSU shares are not covered by cost basis reporting the same way purchased shares are.
Here is why that bites. Say your RSUs vest at $50 per share and you later sell at $55. Your real gain is $5 per share. If the 1099-B shows a $0 basis, the IRS sees a $55 gain. File without adjusting and you pay tax on income you already paid tax on through your W-2. On a short-term sale, that mistake can nearly double your tax bill.
The fix is to report the correct adjusted basis on Form 8949. The adjustment equals the compensation income already included on your W-2. Keep exercise confirmations, vesting statements, and W-2s together so you can back up the adjustment if the IRS asks.
Capital Gains When You Later Sell the Shares
The net shares in your account are not finished with tax. When you sell them, you owe capital gains on any appreciation above your basis. That basis is the fair market value on the exercise date (for options) or the vesting date (for RSUs). Sell within one year and the gain is short-term, taxed at ordinary rates. Hold longer than a year and it qualifies for the lower long-term rate.9Internal Revenue Service. Topic No. 409, Capital Gains and Losses If the stock drops below your basis and you sell at a loss, you can deduct it against other gains or up to $3,000 of ordinary income per year.
Why 22% Withholding Usually Is Not Enough
The flat 22% federal rate on supplemental wages is a withholding rate, not your actual tax rate. If you are in the 32% or 35% bracket, 22% withheld at exercise will not cover your federal tax on the gain. State tax widens the gap. Many employees discover the shortfall the following April when they owe thousands more than expected.
You generally must make estimated tax payments if you expect to owe at least $1,000 after withholding and credits, and your total withholding will be less than 90% of current-year tax or 100% of prior-year tax (110% if your prior AGI exceeded $150,000).10Internal Revenue Service. Large Gains, Lump-Sum Distributions, Etc. A practical fix: increase the federal withholding on your regular paycheck for the rest of the year. The IRS treats paycheck withholding as paid evenly throughout the year, so you can avoid underpayment penalties even if you make the change late. Quarterly estimated payments, by contrast, can trigger a penalty if you miss the deadline for the quarter in which the income was recognized.
Wash Sale Risk Around Vesting Dates
If you sell company shares at a loss within 30 days before or after an RSU vest or option exercise, the wash sale rule can disallow the loss. The IRS treats the vest or exercise as an acquisition of substantially identical stock.11eCFR. 26 CFR 1.1091-1 – Losses From Wash Sales of Stock or Securities The 61-day window (30 days before through 30 days after) means a regular monthly or quarterly vesting schedule creates nearly continuous wash sale exposure.
The disallowed loss is not gone forever. It gets added to the basis of the newly acquired shares and comes back when you sell those. But if you were counting on the loss to offset a gain in the current year, you are out of luck. The only reliable fix is to track your vesting schedule and avoid selling company shares at a loss inside the 61-day window.
Alternatives Worth Considering
The cashless route is popular because it costs nothing upfront. Two alternatives can produce better outcomes depending on your cash position and your conviction in the stock.
Cash Exercise and Hold
You pay the strike price and tax withholding yourself and keep every share. More shares mean more upside if the stock climbs. The downside is just as plain: you are tying up cash in a single stock issued by your employer. If the company stumbles, your shares lose value at the same moment your job might be at risk. This only makes sense if you have the savings to absorb the outlay and real conviction in the long-term trajectory.
Net Exercise or Stock Swap
A net exercise reduces the number of shares delivered to you by the amount needed to cover the strike price, with no open-market sale. Nothing trades on an exchange and you need no cash. Some plans also allow a stock swap, where you surrender previously owned shares worth the strike price. Surrendered shares keep their original basis and holding period, which can help if those shares already qualified for long-term treatment. Not every plan offers these, so check your equity plan documents.
Section 83(b) for Early-Exercised Options
Some startup plans let you exercise options before the shares fully vest. If you do, you can file a Section 83(b) election with the IRS within 30 days of exercise, choosing to pay ordinary income tax on the current value of the shares rather than the potentially higher value at vesting.6Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options If the company is early-stage and the shares are worth almost nothing, the savings can be enormous. The 30-day deadline is absolute, though, and the election cannot be revoked. Miss the window and you are taxed on vest-date value. File it and then leave the company before vesting, and you do not get back the tax you already paid.