An equity grant is a form of compensation that gives you an ownership stake in the company you work for, delivered either as actual shares of stock or as the right to buy shares at a locked-in price. Companies use equity to tie your pay to long-term growth while conserving cash, and the value of what you receive rises and falls with the stock price. Almost every grant comes with a vesting schedule, which means you have to stay at the company (or hit certain targets) before the equity is actually yours.
How Vesting Decides When You Actually Own It
Every grant has a grant date that sets the terms: how many shares, what type, and the reference price for any options. The grant date is not the date you own anything. Ownership comes through vesting.
The common pattern at public and late-stage companies is four-year vesting with a one-year cliff. Leave before your first anniversary and you walk away with nothing. Pass the cliff and a chunk (typically 25%) vests at once, with the rest vesting monthly or quarterly over the remaining three years. Some companies use performance-based vesting instead, tying your equity to revenue goals, stock price milestones, or operational targets. A few plans combine both.
Once shares vest, you own them outright if the grant is restricted stock units or restricted stock awards. If the grant is stock options, vesting gives you the right to exercise, meaning the right to buy the shares at your locked-in price.
The Main Types of Equity Grants
Restricted Stock Units (RSUs)
RSUs are the most common equity grant at publicly traded companies. An RSU is a promise to deliver actual shares once you meet the vesting requirements. You pay nothing to receive the shares. When they vest, the company deposits them into your brokerage account and the full market value counts as taxable income. Some RSU plans also credit you with dividend equivalents, which are taxed as ordinary wages when paid out.
Stock Options (ISOs and NSOs)
A stock option gives you the right to buy a set number of shares at a fixed exercise price (also called the strike price), almost always set at the stock’s fair market value on your grant date. The option is only valuable if the stock rises above that strike. The difference between the current price and your strike is the spread, and that’s your potential profit.
Incentive stock options (ISOs) are available only to employees and carry special tax advantages if you follow strict holding rules. Federal law caps the amount of ISOs that can become exercisable for the first time in any calendar year at $100,000 worth of stock, measured by fair market value on the grant date.1eCFR. 26 CFR 1.422-4 – $100,000 Limitation for Incentive Stock Options Any options over that threshold automatically convert to non-qualified stock options. ISOs also expire no later than 10 years from the grant date.2Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options
Non-qualified stock options (NSOs) don’t meet the statutory requirements for ISOs under Section 422, so they don’t get the same tax breaks. In exchange, they’re more flexible: companies can grant NSOs to contractors, advisors, and board members, not just employees.
Restricted Stock Awards (RSAs)
An RSA gives you actual shares on day one. You own the stock immediately, can vote it, and may receive dividends. But the shares are restricted. If you leave before vesting, the company buys back the unvested shares, usually for whatever you paid (often nothing). RSAs are most common at early-stage startups where the stock has a low current value, which makes them a natural fit with the 83(b) election described below.
When You Owe Taxes on Each Type
Tax treatment varies sharply by grant type, and the timing is rarely intuitive. The general rule under federal law is that when you receive property for performing services, you owe income tax once the property is no longer at risk of forfeiture.3Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection with Performance of Services How that trigger shows up depends on what you were granted.
RSUs: Taxed at Vesting
RSUs create a single taxable event on the vesting date. The full fair market value of the delivered shares is ordinary income, subject to federal income tax, state income tax, Social Security, and Medicare. Your employer reports it on your W-2.
Most companies use sell-to-cover, automatically selling enough of the newly vested shares to handle withholding. The problem is that federal supplemental wage withholding is a flat 22% (or 37% if your total supplemental wages for the year exceed $1 million). If your actual marginal rate is higher, the withholding won’t cover your bill. Employees in the 32% or 35% bracket often find a five-figure gap at tax time. Run the math when shares vest and set aside the difference or make estimated payments.
After vesting, your cost basis in the shares equals the fair market value on the vesting date. Sell within a year and any additional gain is a short-term capital gain taxed at ordinary rates; hold longer than a year for long-term capital gains rates.4Internal Revenue Service. Topic No. 409 Capital Gains and Losses
NSOs: Taxed Twice
NSOs are taxed in two stages. First, at exercise: the spread between the stock’s current market value and your strike price is ordinary income, reported on your W-2, with the same supplemental withholding gap as RSUs. Second, at sale: your cost basis is the market value on the exercise date, and any additional gain is a capital gain, long-term if you held the shares more than a year after exercise.
ISOs: Best Tax Deal, Hardest Rules
ISOs offer the most favorable tax treatment in equity compensation, but only if you follow two holding periods: at least two years from the grant date and at least one year from the exercise date.2Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options Meet both and the entire gain from strike price to sale price is a long-term capital gain. No ordinary income tax at exercise. No payroll taxes on the spread.
The trap is the alternative minimum tax. When you exercise ISOs and hold the shares, the spread between strike price and market value becomes an AMT preference item. You can owe AMT without selling anything or receiving any cash.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Model the AMT before you exercise. The call between exercise-and-hold (for capital gains) versus exercise-and-sell-immediately (which avoids AMT) depends on your income, the size of the spread, and how much you expect the stock to appreciate.
There is a partial fix. AMT paid because of ISO exercises generates a minimum tax credit you can use in future years when your regular tax exceeds your tentative minimum tax. The credit carries forward indefinitely until recovered, claimed on IRS Form 8801.6Internal Revenue Service. Instructions for Form 8801 Most people recover it gradually over several years after selling the shares.
Sell ISO shares before clearing both holding periods and the sale becomes a disqualifying disposition. The lesser of your actual gain or the spread at exercise gets reclassified as ordinary income, with any remaining gain treated as a capital gain based on how long you held. Your employer reports the exercise on Form 3921.7Internal Revenue Service. About Form 3921, Exercise of an Incentive Stock Option Under Section 422(b)
The 83(b) Election for Restricted Stock
If you receive a restricted stock award, you can file an 83(b) election to pay ordinary income tax immediately on the stock’s current value instead of waiting for vesting. The election must be filed with the IRS within 30 days of receiving the shares, and the deadline is absolute.8Internal Revenue Service. Form 15620 – Section 83(b) Election Miss it by one day and the election is gone.
The bet is that the stock will be worth much more at vesting. File on stock worth $1 per share and you pay ordinary tax on $1 now; if it’s worth $50 at vesting three years later, the $49 of appreciation is taxed at long-term capital gains rates when you sell.
The risk is real. If you file an 83(b) and later forfeit the stock by leaving the company, the statute explicitly bars any deduction for the forfeiture.3Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection with Performance of Services You paid tax on income you never kept. The only deduction available is a capital loss limited to whatever you actually paid out of pocket, which for many startup grants is zero. File only when you’re confident you’ll stay through vesting and the stock has a low current value worth locking in.
Exercising Stock Options
Once your options vest, you decide when and how to buy the shares. RSU holders skip this entirely because their shares are delivered automatically. For option holders, the question is how to fund the purchase.
- Cash exercise: you pay the strike price out of pocket and keep all the shares. This is the standard approach for ISOs you intend to hold for long-term capital gains treatment, because there’s no sale to trigger disqualification.
- Sell-to-cover: your broker sells just enough newly acquired shares to cover the strike price and any tax withholding, depositing the rest in your account.
- Cashless exercise: the broker sells enough shares to cover the strike price, taxes, and fees, and you receive the net cash or remaining shares. Popular for NSOs because it requires no out-of-pocket money.
- Net exercise: instead of selling shares on the market, the company withholds a portion of your option shares to cover the strike price. Private companies sometimes use this when there’s no public market.
Every exercise method for NSOs triggers ordinary income tax on the spread. The choice between methods is about cash flow and how many shares you want to keep, not the tax outcome.
What Happens If You Leave or the Company Is Acquired
Unvested equity disappears when you walk out the door. If you haven’t passed the cliff or finished your vesting schedule, those shares or options are forfeited.
Vested options come with a post-termination exercise period, often 90 days but sometimes shorter. Your grant agreement sets the exact window. Don’t exercise in time and your vested options expire worthless, no matter how deep in the money they are. For ISOs there’s an additional federal rule: you must exercise within 90 days of leaving to keep the ISO tax treatment. Exercise after day 90 and the options automatically become NSOs, so the spread at exercise is ordinary income subject to payroll taxes.2Office of the Law Revision Counsel. 26 U.S. Code 422 – Incentive Stock Options Some companies extend the window to several years, but the IRS will not extend the ISO benefit along with it.
Termination for cause is worse. Many equity plans let the company cancel both vested and unvested options if you’re fired for misconduct, and some include clawbacks that require you to repay the value of previously exercised equity. Vested RSUs that have already settled into your brokerage account are yours, absent a clawback triggered by specific misconduct. Unvested RSUs are forfeited on your last day.
In an acquisition, your unvested equity doesn’t automatically disappear. The treatment depends on acceleration provisions in your grant agreement. Single-trigger acceleration means some or all of your unvested equity vests when the deal closes. Double-trigger requires two events: the acquisition and your termination (or a significant change in your role) within a defined period afterward, typically 9 to 18 months. Double-trigger is far more common because buyers and investors want the team to stay.
Selling Your Shares Isn’t Always Immediate
Vested shares aren’t always shares you can sell. Publicly traded companies impose blackout periods, usually starting two to three weeks before the end of each fiscal quarter and lasting a day or two after earnings. During a blackout, employees covered by the insider trading policy cannot buy or sell company stock.
If you’re an affiliate (executive officer, director, or major shareholder), SEC Rule 144 caps how much stock you can sell in any three-month period at the greater of 1% of outstanding shares or the average weekly trading volume over the prior four weeks.9Securities and Exchange Commission. Rule 144: Selling Restricted and Control Securities
Private company equity is a different problem. With no public market, your shares may be illiquid for years. Some companies run periodic tender offers that let employees sell to the company or outside investors at a set price. Others permit direct secondary sales, though the company usually holds a right of first refusal to block or match. Until the company goes public or is acquired, your equity may be valuable on paper and practically inaccessible.
Reporting Mistakes That Cost You Money
Cost Basis Double-Taxation
When you sell shares acquired through equity compensation, your broker reports the sale on Form 1099-B. The cost basis on that form often doesn’t account for the ordinary income you already paid tax on at vesting or exercise. Copy the 1099-B figures straight to your return and you’ll pay tax twice on the same income. Fix this by reporting the sale on Form 8949 and entering an adjustment in column (g) to reflect your true cost basis, which includes the previously taxed income.10Internal Revenue Service. Instructions for Form 8949 This is where most equity tax returns go wrong, almost always resulting in overpayment.
The Wash Sale Rule and RSU Vesting
The wash sale rule disallows a tax loss if you buy substantially identical stock within 30 days before or after selling at a loss.11Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss from Wash Sales of Stock or Securities RSU vesting counts as acquiring new shares. Sell company stock at a loss within the 61-day window around a vest date and the loss is disallowed, added instead to the basis of the newly vested shares. Even sell-to-cover transactions on the vesting date can trigger it. Check your vesting calendar before harvesting losses on company stock.
Section 409A at Private Companies
Section 409A governs deferred compensation, and stock options at private companies are the most common place it bites. If the exercise price is set below fair market value (often because the company skipped or botched its 409A valuation), the options become noncompliant deferred compensation. The penalty falls on you: upon vesting, the deferred compensation is included in your gross income, hit with a 20% additional tax, and assessed interest from the date it first vested at the underpayment rate plus one percentage point.12Office of the Law Revision Counsel. 26 U.S. Code 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans If you’re joining a private company and receiving options, asking whether the company has a current 409A valuation is reasonable and self-protective.
Read Your Grant Agreement
Two documents control your equity, and most employees never open either. The stock incentive plan is the master document approved by the board and shareholders, setting the share pool, eligibility, and boundaries for every grant. Your individual grant agreement is the contract between you and the company, specifying the number of shares or options, grant date, exercise price, and vesting schedule.
Pay attention to the forfeiture and clawback provisions. Clawbacks allow the company to recover previously vested equity years after you received it, often tied to executive misconduct, financial restatements, or breach of a non-compete. These provisions are increasingly common and increasingly aggressive. The grant agreement also governs your post-termination exercise window and any acceleration rights in a change of control. Read it before your first batch of options vests, not the day you clean out your desk.