Updated July 28, 2026. Quick answer: RSUs are ordinary income at vest and your employer almost certainly under-withholds on them. ISOs are not taxed at exercise for regular tax but can trigger AMT. ESPP depends entirely on how long you hold after purchase.
The three instruments, and what actually triggers tax
| Instrument | Taxable event | Character |
|---|---|---|
| RSU | Vest | Ordinary income on the full value, reported on your W-2 |
| NSO | Exercise | Ordinary income on the spread |
| ISO | Exercise (AMT only); sale (regular tax) | No regular tax at exercise; the spread is an AMT preference item |
| ESPP | Purchase and sale | Split between ordinary income and capital gain, depending on holding period |
The withholding gap is the problem nobody warns you about
Supplemental wages — which is what a vest is — are withheld at a flat 22% up to $1,000,000 for the year, and 37% above that. That flat rate is an estimate, not your tax. If your marginal rate is 32% or 35%, every vest quietly under-withholds by ten to thirteen points, and you find out in April.
Work out your own gap — it takes the vest value and your marginal rate and tells you the shortfall.
The limits worth knowing before you plan anything
- 83(b) election: 30 days. Not 30 business days, not extendable. IRC §83(b)(2).
- ISO $100,000 rule. Only $100,000 of ISO value (measured at grant) can first become exercisable in a calendar year; the excess is treated as NSOs. IRC §422(d).
- ESPP $25,000 per year, measured at grant-date value. IRC §423(b)(8).
Where people actually lose money
Not on the choice between instruments — you rarely get one — but on four avoidable mechanics: under-withholding at vest, a zero cost basis on the 1099-B, missing the 30-day 83(b) window, and holding a concentrated position by default rather than by decision. Every one of those is a process failure rather than a judgement call.
Sequence for a new grant
Read the grant agreement for vesting triggers and termination treatment. Work out the withholding gap for the first vest. Decide the sell-or-hold rule before the shares arrive. Check the first 1099-B against the vest-date value. Those four steps handle most of it.
Sources
IRC §83; IRC §83(b)(2); IRC §422(d); IRC §423(b)(8); IRC §3402(g)(1)(A); Treas. Reg. §31.3402(g)-1.
This states what the cited authority says. It is not tax advice, and equity compensation interacts with the rest of your return in ways a single page cannot see.
Related
Stock options and ESPP
Concentrated stock and employer shares
Once the shares are yours, the question shifts from tax mechanics to what to do with a position that correlates with your paycheck:
- NUA vs IRA rollover — employer stock in a 401(k) can be capital gain, not ordinary income
- The concentration hiding inside your 401(k)
- Your five real options for a concentrated position
- Donating appreciated shares instead of cash
- A tax plan for selling down