If you work at a private or public company, chances are your compensation package includes more than just a paycheck. Many companies — especially in tech and high-growth industries — also grant equity compensation. It’s a way to make you an owner in the business, sharing in its success if the company grows.
But here’s the challenge: equity comes in many different forms, and each works a little differently. If you’ve ever felt confused by acronyms like RSU, RSA, ISO, or NSO, you’re not alone. Let’s break down the basics so you can understand what you’ve been granted, how it works, and what it may mean for your taxes.
The Common Types of Equity Awards
Restricted Stock Units (RSUs)
Think of RSUs as a company “IOU.” Your employer promises to give you stock if you meet certain requirements, usually staying at the company for a set period of time.
- When you get the shares: At vesting.
- What you pay: Nothing — they’re granted to you.
- Taxes: The fair market value at vesting is taxed as ordinary income (just like cash salary). Any later gain when you sell is taxed as capital gains.
Restricted Stock Awards (RSAs)
early-stage startups when the stock’s value is very low.
- When you get the shares: Immediately, but they’re subject to forfeiture until they vest.
- What you pay: Usually the nominal fair market value at grant.
- Taxes: Taxed as income when they vest unless you file an 83(b) election within 30 days of the grant. Filing early means you pay tax upfront (often at a very low value), and future growth can qualify for capital gains treatment.
Stock Options (ISOs and NSOs)
Options give you the right to buy company stock at a fixed price (the “strike” or “exercise” price). If the company’s value grows above that price, you can exercise and potentially profit.
- Incentive Stock Options (ISOs):
- Available only to employees.
- Offer favorable tax treatment if you meet specific holding requirements (at least one year after exercise and two years after the grant date).
- Can trigger the Alternative Minimum Tax (AMT) — more on that below.
- Non-Qualified Stock Options (NSOs):
- Can be granted to employees, consultants, or directors.
- Simpler tax treatment: the difference between the market value and strike price at exercise is taxed as ordinary income.
- Later gains or losses are taxed as capital gains when you sell.
Vesting: The Waiting Game
Most equity awards don’t fully belong to you right away. Instead, they vest over time – typically a four-year schedule with a one-year “cliff.” This may mean:
- At your one-year anniversary, 25% of your grant vests.
- The remaining 75% vests in monthly or quarterly increments over the next three years.
Vesting is designed to reward you for staying with the company. Leave early, and you may forfeit unvested shares.
Taxes: What You Need to Know
Equity is valuable, but it comes with tax strings attached. Here are the high-level rules of thumb:
- Ordinary income taxes apply at vesting (for RSUs/RSAs) or at exercise (for NSOs, sometimes ISOs).
- Capital gains taxes apply when you sell shares. Long-term capital gains (held >1 year) likely get lower rates than short-term (≤1 year).
- 83(b) election lets RSA holders choose to pay tax early, which can save money if the company’s stock price grows.
A Closer Look at AMT (Alternative Minimum Tax)
If you exercise ISOs, you may run into the Alternative Minimum Tax (AMT). AMT is a parallel tax system designed to make sure people with certain types of income still pay a minimum level of tax.
Here’s why ISOs are tricky:
- When you exercise ISOs, you don’t owe regular income tax right away.
- But for AMT purposes, the “spread” (the difference between the stock’s fair market value and your strike price) is treated as income.
- If the spread is large, it can push you into paying AMT — even though you haven’t sold the stock or made any cash.
Example:
- You exercise 5,000 ISOs with a strike price of $1.
- The fair market value is $10 at the time of exercise.
- The $45,000 spread ($9 per share × 5,000 shares) counts as income for AMT.
This can create a cash flow issue: you may owe taxes without actually having sold shares to cover the bill. Many employees work with tax advisors to time ISO exercises carefully and avoid unexpected AMT liabilities.
Key Takeaways
- RSUs = “IOUs” from your company, taxed at vesting.
- RSAs = Stock you own right away, but may need an 83(b) to manage taxes efficiently.
- ISOs = Potentially tax-advantaged, but watch for AMT and holding requirements.
- NSOs = Simpler options, but taxed as income at exercise.
- Vesting = Your ownership comes in stages, not all at once.
- Taxes can be as important as the stock itself — plan early, especially around AMT.
Equity compensation can be one of the most rewarding parts of your job — but only if you understand what you’ve got and how it works. Take time to learn the basics, pay attention to vesting and taxes, and don’t hesitate to ask your HR team, tax advisor, or financial planner for help. What looks like just a jumble of acronyms today could turn into life-changing wealth tomorrow.
