The tax difference between an RSU and an ISO comes down to timing and character. Restricted stock units are taxed as ordinary income the moment they vest, with federal, Social Security, and Medicare taxes withheld like a paycheck. Incentive stock options skip regular income tax at exercise but can trigger the Alternative Minimum Tax, and they only deliver their full tax advantage if you hold the shares long enough to turn the entire profit into long-term capital gain. That contrast is the whole story of RSU vs ISO tax treatment, and every planning decision flows from it.
How RSUs Are 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 hits when the RSUs vest. The full fair market value of the delivered shares counts as ordinary income 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 before the shares land in your brokerage account.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 withhold by keeping a portion of your vesting shares and selling them, a process called net settlement or sell-to-cover. The federal supplemental wage withholding rate is 22% for amounts up to $1 million, which is almost always below the actual marginal rate of someone receiving meaningful equity. That gap means you may owe additional tax at filing. State withholding stacks on top, and in high-tax states the shortfall can be significant.
After vesting, your cost basis in the shares equals the fair market value on the vesting date. Anything the stock does from that point forward is a capital gain or loss when you sell.
One boundary worth flagging because the terms get confused: the Section 83(b) election does not apply to standard RSUs. It applies to restricted stock awards, where actual shares transfer at grant subject to a vesting restriction.3Internal Revenue Service. Form 15620 – Section 83(b) Election An RSU is just a promise, so there’s no property transfer for an 83(b) to attach to.1Office of the Law Revision Counsel. 26 USC 83 – Property Transferred in Connection With Performance of Services If someone recommends an 83(b) for your RSUs, confirm whether you’re actually holding RSAs.
Private-company RSUs usually carry a second vesting condition on top of the time schedule, typically a liquidity event like an IPO or acquisition. Until both triggers fire, nothing settles and no tax is owed. The structure exists so you don’t get stuck with a tax bill on illiquid shares you can’t sell to pay it.
How ISOs Are Taxed
An ISO gives you the right to buy company shares at a locked-in strike price, set at the stock’s fair market value on the grant date. The grant creates no tax event. The options vest on a schedule, and once vested, you choose when (and whether) to exercise by paying the strike price in cash.
Here the paths diverge. Exercising ISOs does not trigger regular federal income tax, Social Security tax, or Medicare tax. The spread between the strike price and the fair market value at exercise does not appear on your W-2. For regular tax purposes, nothing happened.4Office of the Law Revision Counsel. 26 USC 421 – General Rules for Certain Stock Options
That deferral is the whole appeal of ISOs. The catch sits one line down the tax code.
The AMT Trap at Exercise
The spread at exercise, invisible for regular income tax, is an adjustment item for the Alternative Minimum Tax. The AMT is a parallel calculation that adds back certain preference items to make sure higher-income taxpayers pay at least a floor amount of federal 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
The AMT calculation starts with your regular taxable income, adds back the ISO spread and other adjustments, then subtracts an exemption. For 2026, the exemption is $90,100 for single filers and $140,200 for married filing jointly, phasing out beginning at $500,000 and $1,000,000 respectively.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Anything above the exemption is taxed at 26% up to $244,500 and 28% above that.8Office of the Law Revision Counsel. 26 USC 55 – Alternative Minimum Tax Imposed
The practical pain: you owe this tax in cash even though you haven’t sold any stock. You paid the strike price out of pocket, you hold shares you may not want to sell (especially if you’re trying to meet the holding period for long-term capital gains), and now you owe the IRS. Exercising a large block of ISOs with a big spread in one year can produce an AMT bill of tens of thousands with no liquidity to cover it.
The AMT Credit
AMT paid because of an ISO exercise generates a minimum tax credit that carries forward indefinitely. In any later year where your regular tax exceeds your tentative minimum tax, you can use the credit to reduce what you owe.9Office of the Law Revision Counsel. 26 USC 53 – Credit for Prior Year Minimum Tax Liability You eventually get the money back. But “eventually” can stretch across many years, and the time value is real. Treat it as an interest-free loan to the government.
The $100,000 ISO Limit
Federal tax law caps the value of ISOs that can first become exercisable by any employee in a single calendar year at $100,000, measured by the fair market value of the underlying stock on the grant date.10Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options Anything above the threshold in a given year is automatically reclassified as non-qualified stock options. NSOs don’t get the AMT-only treatment; the spread at exercise is taxed as ordinary income subject to income and payroll taxes, just like RSU vesting income.
This matters most when a company grants a large option package with heavy early vesting. If 50,000 options with a $3 grant-date FMV all become exercisable in the same year, only the first 33,333 options keep ISO status. The rest flip to NSO treatment automatically, often with no notice from the employer. Run the calculation yourself before exercising a large grant.
Selling the Shares
Whether you got shares through RSUs or ISOs, selling them triggers a capital gain or loss. The treatment depends on your basis, your holding period, and for ISOs, whether you cleared two separate holding windows.
RSU Shares
Your basis in RSU shares is the fair market value on the vesting date, the same amount already taxed as ordinary income. Sell more than one year after vesting and the gain is long-term, taxed at 0%, 15%, or 20% depending on your income. Sell within a year and it’s short-term, taxed at your ordinary rate.11Internal Revenue Service. Topic No. 409, Capital Gains and Losses Your brokerage reports the sale on Form 1099-B.12Internal Revenue Service. About Form 1099-B, Proceeds From Broker and Barter Exchange Transactions
Selling at vesting usually produces close to zero capital gain because the sale price and the vesting-date FMV are nearly the same. A common misread: assuming no tax is owed on that same-day sale. The ordinary income tax was already triggered at vesting; the sale just avoids additional gain or loss on top.
ISO Shares: Qualifying vs. Disqualifying Dispositions
ISO shares get the best treatment only if you clear two separate clocks before selling: at least two years from the grant date and at least one year from the exercise date. Both must run.10Office of the Law Revision Counsel. 26 USC 422 – Incentive Stock Options
Clear both and the sale is a qualifying disposition. Your basis is the strike price, and the entire gain from strike to sale is long-term capital gain. No portion of the spread is taxed as ordinary income. That’s the scenario ISO holders aim for.
Miss either clock and it’s a disqualifying disposition. The ordinary income portion equals the lesser of the spread at exercise or the actual gain on the sale, and that amount gets reclassified as ordinary income on your W-2. Any remaining profit above the spread is capital gain, long- or short-term depending on how long you held after exercise.4Office of the Law Revision Counsel. 26 USC 421 – General Rules for Certain Stock Options
Your employer files Form 3921 in the year you exercise ISOs, documenting the grant date, exercise date, strike price, and FMV. Keep it; you’ll need it to compute both your potential AMT and the tax on an eventual sale.13Internal Revenue Service. Instructions for Forms 3921 and 3922
Wash Sales Can Catch You by Accident
Sell company stock at a loss and acquire substantially identical shares within 30 days before or after the sale, and the IRS disallows the loss under the wash sale rule.14eCFR. 26 CFR 1.1091-1 – Losses From Wash Sales of Stock or Securities The disallowed loss shifts into the basis of the replacement shares, so it’s deferred rather than lost.
RSU vesting counts as an acquisition. If you sell older company shares at a loss and new RSUs vest within the 30-day window on either side, you’ve triggered a wash sale whether you intended to or not. The same applies to ISO exercises. Selling RSU shares immediately on vesting avoids building up older lots that could later be sold at a loss near a future vest date. For employees subject to blackout periods, a pre-arranged 10b5-1 plan can keep sales from colliding with vesting dates.
RSUs vs. ISOs Side by Side
- Tax at grant: neither creates a tax event.
- Tax at vesting or exercise: RSUs produce ordinary income at vesting with automatic withholding; ISOs produce 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 outlay: RSUs require nothing from you; ISOs require you to pay the strike price, plus potentially an AMT bill.
- Capital gains: RSU holders get long-term rates only on appreciation after vesting; ISO holders who clear both holding periods get long-term rates on the entire gain from strike to sale.
- Risk of worthlessness: vested RSUs retain value unless the stock hits zero; ISOs become worthless if the stock drops below the strike price.
- Complexity: RSUs are one taxable event with withholding handled for you; ISOs involve AMT, two holding periods, disqualifying-disposition risk, and a credit carryforward.
When Each One Works Best
ISOs reward conviction and liquidity. If you believe in the stock, have the cash to cover the strike price and any AMT bill without selling, and can hold through both required periods, you convert the entire gain to long-term capital gain. That is meaningful savings compared to the same appreciation running through RSUs as ordinary income. The flip side is concentration risk, locked-up capital, and an AMT bill due in cash.
RSUs reward simplicity. You put up nothing, withholding happens automatically, and you can sell at vesting to clear the concentration. The tradeoff is that every dollar of value is ordinary income first, with capital gains rates available only on what the stock does after vesting.
Plenty of employees hold both. The usual mistake is treating them as separate problems. Exercising a block of ISOs in the same year a large RSU tranche vests can push combined income into AMT territory you didn’t anticipate, because the RSU income raises the baseline against which the ISO spread is measured. Running Form 6251 before year-end rather than after is the single most valuable move you can make with equity compensation. If the numbers are large, an advisor who models equity scenarios can usually find a sequence that lowers total tax across both grants.