Startup equity can be a powerful wealth-building tool—but only if you understand how it’s taxed. The three most common forms of compensation are ISOs (Incentive Stock Options), NSOs (Nonqualified Stock Options), and RSUs (Restricted Stock Units). Each has different tax timing, rates, and planning considerations. In this in-depth guide, we compare ISOs vs NSOs vs RSUs, explain how each is taxed from grant to sale, and share practical strategies to optimize after-tax outcomes.
ISOs: Incentive Stock Options
ISOs can qualify for favorable long-term capital gains treatment if you meet the holding periods (1 year after exercise and 2 years after grant). However, ISO exercises may trigger the Alternative Minimum Tax (AMT) due to the bargain element.
- Grant: No tax.
- Exercise: No regular tax; AMT preference on the bargain element; no withholding.
- Sale: If qualifying disposition, LT capital gains on strike-to-sale spread; otherwise, ordinary income for part/all of the spread.
Use our ISO AMT Calculator to estimate AMT before exercising large tranches.
NSOs: Nonqualified Stock Options
NSOs are simpler for taxes at exercise: the spread between FMV and strike is ordinary income and subject to withholding and payroll taxes. Later gains or losses after exercise are capital in nature.
- Grant: No tax.
- Exercise: Ordinary income on the spread; employer withholds taxes (federal, state, FICA/Medicare).
- Sale: Capital gains/losses based on post-exercise holding period.
NSOs provide more predictable cash tax at exercise but fewer opportunities for long-term capital gains on the full spread.
RSUs: Restricted Stock Units
RSUs tax at vest: the FMV at vest is ordinary income and typically subject to employer withholding (often via share withholding). Subsequent appreciation or depreciation is capital gain or loss.
- Grant: No tax.
- Vest: Ordinary income based on FMV at vest; shares delivered; employer withholds.
- Sale: Capital gains/losses based on post-vest holding period.
Side-by-Side Comparison
- Cash at exercise/vest: ISOs (no withholding), NSOs (withholding at exercise), RSUs (withholding at vest).
- Top tax risk: ISOs (AMT on bargain element), NSOs (ordinary income + payroll taxes), RSUs (ordinary income at vest).
- Best-case rates: ISOs (LT capital gains on qualifying disposition), NSOs (capital gains after exercise), RSUs (capital gains after vest).
- Complexity: ISOs (highest due to AMT/holding periods), NSOs (moderate), RSUs (lowest).
Planning Strategies by Equity Type
ISOs
- Stage exercises across years to manage AMTI and AMT exemption.
- Track AMT credit for future usage in high regular tax years.
- Aim for qualifying dispositions when feasible; model cash needs and risk of price declines.
NSOs
- Compare cash exercise vs same-day sale to manage withholding and risk.
- Exercise earlier to start the capital gains holding period if you can tolerate risk.
- Watch AMT (not applicable) but plan for payroll taxes and estimated payments if needed.
RSUs
- Decide whether to sell-to-cover taxes and diversify immediately at vest.
- Model alternative minimum withholding vs supplemental withholding if available.
- Consider gifting or charitable strategies (e.g., Donor Advised Funds) for appreciated shares.
What If You Have Multiple Equity Types?
Many employees hold a mix of ISOs, NSOs, and RSUs. A coordinated plan can improve after-tax outcomes:
- Use RSU/NSO ordinary income years to help utilize ISO AMT credit.
- Exercise small ISO tranches in low-income years to minimize AMT risk.
- Maintain a diversification policy to avoid concentration risk while respecting holding periods.
Frequently Asked Questions
Which equity type is best?
No single type is “best” in all cases. ISOs can be excellent if you can manage AMT and meet holding periods. NSOs provide predictable tax at exercise. RSUs are simple but create ordinary income at vest.
Should I always hold for long-term gains?
Long-term treatment is attractive, but risk and cash needs matter. Consider selling some shares to diversify and cover taxes.
Do I need a CPA?
If you exercise ISOs or juggle multiple equity types, a CPA can help model AMT, credit usage, and estimated payments.
Next Steps
Compare scenarios using our calculators and deep dives:
- ISO AMT Calculator to estimate AMT from ISO exercises
- ISO Taxes and AMT Basics for bargain element and holding period rules
- AMT Credit Guide to understand how to reclaim prior-year AMT
