Equity compensation can become the largest part of an executive’s wealth, and the most confusing part of their taxes.
Each type has its own timing. Some are taxed when they vest, some when you exercise, some only when you sell. And the default withholding on equity pay is often well below what high earners actually owe.
How each type is taxed
| Type | Taxed when | Taxed as | Watch for |
|---|---|---|---|
| Restricted stock units (RSUs) | At vesting | Ordinary income on the shares’ value | Withholding at 22% often too low |
| Nonqualified stock options (NSOs) | At exercise | Ordinary income on the spread | Large exercises spike your bracket |
| Incentive stock options (ISOs) | At sale, if held long enough | Long-term capital gain if requirements are met | The spread at exercise can trigger AMT |
| ESPP shares | At sale | Part ordinary income, part capital gain | Holding periods change the split |
| Restricted stock (not RSUs) | At vesting, or at grant with an 83(b) election | Ordinary income | The 83(b) election has a 30-day deadline |
The withholding trap
Employers usually withhold federal tax on equity pay at a flat 22%. That rises to 37% only on supplemental wages above $1 million in a year.
If your actual bracket is 32%, 35% or 37%, every RSU vest leaves a gap you’ll owe in April, plus New York tax. Adjust withholding or make estimated payments.
- Withheld at the flat rate
- $55,000
- Federal tax on the equity
- $69,301
- Effective rate on the equity
- 27.7%
Stock options: when to exercise
NSOs
The spread at exercise is wages. Spreading exercises over several years can keep you out of the top brackets.
ISOs
Hold the shares at least two years from grant and one year from exercise for long-term capital gains. But a large exercise can trigger the alternative minimum tax. Model it first.
Expiration
Options expire, often within 90 days after you leave the company. Know your dates.
Employee stock purchase plans
Many plans let you buy shares at up to a 15% discount. The discount is taxed as ordinary income when you sell, and how much depends on whether you held the shares long enough for a qualifying disposition.
Many people sell right away to lock in the discount and avoid adding to an already concentrated position.
Planning around your equity
- Put every vesting date, exercise window and expiration on one calendar.
- Decide in advance what you’ll do with RSUs as they vest. Keeping them is a choice to buy company stock.
- Decide how much of your net worth should depend on your employer, and sell toward that number on a schedule.
- Use high-income years for charitable gifts of appreciated shares.
- If you’re an insider, coordinate with company trading windows and any 10b5-1 plan.
How Morrowgate helps. Greg builds an equity calendar with you and models the tax on each vest and exercise with your CPA. He sets withholding or estimated payments, and plans how much company stock to keep and how to spread out the rest. Shares and proceeds can be held in your name at Fidelity, with Schwab available.
Questions executives ask
Are RSUs taxed twice?
No. You pay income tax on the value at vesting, which becomes your cost basis. When you sell, only the change since vesting is a capital gain or loss.
Why do I owe tax on my RSUs even though tax was withheld?
Because the standard federal withholding rate on supplemental pay is 22%, lower than many executives’ actual bracket.
Should I exercise my ISOs early?
Sometimes, to start the holding period, but it can trigger the alternative minimum tax. Model it before you exercise.
What happens to my options if I leave?
Vested options usually must be exercised within a set window, often 90 days. Unvested options and RSUs are typically forfeited unless your plan says otherwise.
Where this guidance stops
This article is general education on equity compensation taxes: how the rules and the options generally work.
It is not tax, legal or investment advice, and nothing here is a recommendation for your situation. Rules change and outcomes turn on the facts, which is why a CPA and an attorney look at a family’s own numbers before anything is done.
Sources
- IRS Publication 525: Taxable and nontaxable income (stock options, restricted property)
- IRS Publication 15: Employer’s tax guide (supplemental wage withholding)
- IRS Topic 427: Stock options