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

Stock grants are taxed in two stages: ordinary income when the shares become yours (at vesting, exercise, or purchase, depending on the grant type), and capital gain or loss when you later sell. The first stage lands on your W-2 and is subject to income tax plus Social Security and Medicare. The second follows capital gains rules, with long-term rates as low as 0%. Which event triggers the ordinary income piece, and what your cost basis is at sale, depends entirely on whether you hold RSUs, restricted stock, NSOs, ISOs, or ESPP shares.

The Two Kinds of Income Every Grant Produces

Ordinary income is the gap between what you paid for the shares (often zero) and their market value at the moment they become yours for tax purposes. It is taxed at your regular federal rate, with Social Security tax of 6.2% up to the wage base and Medicare tax of 1.45%, plus an additional 0.9% on earnings above $200,000 for single filers. Your employer withholds and reports it on your W-2.

Capital gains or losses arise when you sell for more or less than your tax basis. Held one year or less, a gain is short-term and taxed at ordinary rates. Held longer, it is long-term; for 2026, the rate is 0% on taxable income up to $49,450 for single filers ($98,900 joint), 15% up to $545,500 ($613,700 joint), and 20% above those thresholds.¹²

Get the triggering date 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 to deliver shares once you satisfy a vesting condition, usually continued employment. You own nothing until the vesting date, which makes the tax picture clean.

On the vesting date, the full market value of the delivered shares is ordinary income. If 100 shares vest at $50, you have $5,000 of W-2 income that day. Employers withhold 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.³ Many companies handle this through a sell-to-cover arrangement, selling enough shares at vesting to pay the tax and depositing the rest in your brokerage account.

That $50 per-share vesting-date value 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 it is long-term.¹

Watch the withholding gap. The 22% flat rate often falls short of what you actually owe, especially if the vesting pushes you into the 32% or 35% bracket. You will owe the difference at filing. Plan for it, or make an estimated payment in the quarter the vesting hits.

Restricted Stock Awards and the 83(b) Election

Restricted stock awards transfer actual shares on the grant date, subject to forfeiture if you leave before vesting. By default under Section 83, no tax is due until the forfeiture risk lifts; at vesting, the full market value is ordinary income, same as an RSU.⁴

The difference is an option RSU holders don’t have: the Section 83(b) election. Filing it lets you recognize ordinary income on the grant-date value instead of waiting for vesting. If the stock is worth $2 at grant and $40 three years later at vesting, paying ordinary tax on $2 rather than $40 is a large swing. All appreciation from the grant date forward then becomes capital gain, and the long-term holding clock starts on the grant date.⁴

The election must be filed with the IRS within 30 days of the transfer date. Miss it by a day and the opportunity is gone. The election cannot be revoked.⁵ A copy should go to your employer.

The downside: if you file an 83(b) and later forfeit the shares, you get no deduction for the tax already paid. The election fits best when the grant-date value is low, the stock has real growth potential, and you expect to stay through vesting. On late-stage shares that are already expensive, the math shifts.

Non-Qualified Stock Options (NSOs)

NSOs give you the right to buy shares at a fixed strike price set on the grant date. Nothing happens at grant and nothing happens at vesting. The first tax event is exercise.⁶

At exercise, the ordinary income is the market value of the shares on that date minus the strike price. Strike of $10, exercising when the stock is $30, means $20 per share of W-2 income subject to income tax withholding and payroll taxes.⁶

Few employees have cash on hand for both the strike price and the tax, so companies offer cashless alternatives. A sell-to-cover exercises all the options and sells just enough shares to pay the strike price plus withholding, leaving you the rest. A same-day sale exercises and sells everything, giving you the after-tax cash.

If you keep shares after exercise, your cost basis is the market value on the exercise date, which equals the strike price plus the ordinary income already recognized. In the example, basis is $30. Gain above that is capital, with the holding clock starting on the exercise date. Holding past a year earns long-term treatment, at the cost of concentrated exposure to your employer’s stock.

Incentive Stock Options (ISOs)

ISOs look like NSOs on the surface but carry a potential advantage: no ordinary income at exercise for regular tax purposes. Meet the holding rules and the full gain from strike price to sale price can be long-term capital gain.⁷

Qualifying vs. Disqualifying Dispositions

To qualify, you must hold the shares at least two years from the grant date and at least one year from the exercise date. A sale meeting both tests produces a qualifying disposition: the entire gain above the strike price is long-term capital gain, and nothing hits your W-2.⁷

Sell before meeting either holding period and it is 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 like NSO income. Any further gain above the exercise-date market value is capital gain, short- or long-term depending on how long you held after exercise.⁷

The AMT Problem

Even though no ordinary income tax applies 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 floor amount. A large ISO exercise can push AMT above your regular tax and generate a real tax bill in the exercise year, before you have sold anything to pay it with.⁸

AMT paid because of ISOs generates a minimum tax credit that carries forward indefinitely. In later years when regular tax exceeds AMT, the credit offsets your regular bill. Repeated large ISO exercises can keep you stuck in AMT, so recovering the credit takes planning.

The $100,000 Annual Limit

If more than $100,000 worth of ISOs (measured at grant-date value) become exercisable for the first time in a single calendar year, the excess is automatically reclassified as NSOs. Earlier grants keep ISO status; later grants lose it.⁹ Check your grant agreements and vesting schedule so you know which exercises will be treated which way.

Employee Stock Purchase Plans (ESPPs)

A qualified ESPP lets you buy company stock at a discount, often 15% below market, through payroll deductions. The discount and any later appreciation create taxable income, with timing driven by how long you hold.¹⁰

For a qualifying disposition, 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 received at purchase or the gain on the sale; the rest is long-term capital gain.¹¹

Sell before meeting both holding periods and you have a disqualifying disposition. The full discount between the purchase-date market value and the price you paid becomes ordinary income, whether or not you sold at a gain. Any additional gain above the purchase-date market value is capital gain.¹¹

Many ESPPs include a lookback that prices the purchase off the lower of the stock price at the start or end of the offering period, which can enlarge the discount. The qualifying and disqualifying rules still apply the same way. Purchases are capped at $25,000 per calendar year, measured at the offering-date price.¹⁰

Extra Taxes and Rules That Catch People Off Guard

The 3.8% Net Investment Income Tax

Capital gains from selling stock grant shares can trigger a 3.8% surtax. 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 joint, $125,000 married filing separately).¹² Wages are not themselves investment income, but a large RSU vesting or NSO exercise raises your MAGI and can push you over the threshold, exposing capital gains you have in the same year to the surtax.¹³

Wash Sales Triggered by Vesting

The wash sale rule disallows a loss on a stock sale if you acquire 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 inside that 61-day window, the loss is disallowed. The disallowed amount is added to the basis of the newly acquired shares, so it is not permanently lost, but you cannot use it against current-year gains. Employees on regular quarterly or monthly vesting schedules should time loss sales accordingly.

Estimated Tax Payments

A large NSO exercise, ISO disqualifying disposition, or stock sale can create a tax liability that paycheck withholding will not cover. If the gap is significant, you may need estimated payments on Form 1040-ES to avoid an underpayment penalty.¹⁵ Run the numbers after any major vesting or exercise rather than waiting until filing.

The Cost Basis Mistake That Costs People Money

Ordinary income from RSUs, restricted stock without an 83(b) election, and NSOs appears in Box 1 of your W-2. ISO exercises under a qualifying disposition do not create W-2 income for regular tax, but your employer issues Form 3921 reporting the exercise details for AMT.

When you sell, your brokerage sends a Form 1099-B with proceeds and cost basis. For stock compensation, the reported basis is frequently wrong. Brokerages must report basis for options granted after 2013, but the figure often does not include the ordinary income you already recognized at vesting or exercise.¹⁶

Leave it uncorrected and you pay tax twice on the same dollars: once as wages, once as capital gain. To fix it, report the 1099-B basis in column (e) of Form 8949 and enter an adjustment in column (g) for the income already taxed. For RSUs, the correct basis is the market value on the vesting date. For NSOs, it is the market value on the exercise date.¹⁶ This is the single most common and expensive mistake with stock compensation. Check it on every return where you sold grant shares.

1
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
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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
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Internal Revenue Service. Topic No. 427, Stock Options
7
Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options
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Office of the Law Revision Counsel. 26 USC 56 – Adjustments in Computing Alternative Minimum Taxable Income
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eCFR. 26 CFR 1.422-4 – $100,000 Limitation for Incentive Stock Options
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Office of the Law Revision Counsel. 26 USC 423 – Employee Stock Purchase Plans
11
Internal Revenue Service. Stocks (Options, Splits, Traders) 5
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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. Form 1040-ES – Estimated Tax for Individuals
16
Internal Revenue Service. Instructions for Form 8949