ISO vs. NSO vs. RSU Taxes: Exercise, Vesting, AMT and Sale Rules

The three awards differ in one thing that drives everything else: what you actually hold. An option is a right to buy shares at a fixed price you lock in on day one. A restricted stock unit is not an option at all. It is your employer's promise to deliver shares once you meet a vesting condition, so there is nothing to buy and no exercise price to fund.

Options then split into two legal categories, and the line between them is stricter than most grant letters suggest. Statutory options are incentive stock options (ISOs) and options granted under employee stock purchase plans. To stay statutory you must be an employee of the granting company or a related company from the grant date through the point three months before you exercise (one year for an ISO if you are disabled), and the option must be nontransferable except at death. Fail either test and, in the words of the IRS, "your option is a nonstatutory stock option."^[1] That single sentence is why departing employees who exercise late in a post-termination window so often get NSO treatment on an award they were told was an ISO. Employees at technology and SaaS startups routinely see all three instruments inside a single offer.

Answer first: an NSO is taxed at exercise, an RSU is taxed at vesting, and an ISO is taxed at neither under the regular income tax. The IRS states the ISO rule plainly: if your employer grants you a statutory stock option, you generally do not include any amount in gross income when you receive or exercise it.^[2] For a nonstatutory option with no readily determinable value at grant there is no taxable event at grant, and at exercise you include the market value of the shares received less the amount you paid.^[7] An RSU settles into the restricted property rule: once the property becomes substantially vested you include its fair market value, minus anything you paid for it, in income for that year.^[10]

Those three moments do more than fix a due date. Each one resets your basis in the shares at a different number, and the gap between that reset basis and the figure your broker later reports is where most equity compensation returns go wrong.

Exercising an ISO adds nothing to regular gross income, which is the whole point of the award.^[2] What it does add is an alternative minimum tax adjustment. For AMT purposes the shares are treated as if no special rule applied, and once your rights turn transferable, or the substantial risk of forfeiture lapses, the amount by which market value exceeds the option price is entered on Form 6251, line 2i.^[3]

Two consequences follow that option holders routinely miss. First, your AMT basis in those shares is higher than your regular basis by exactly that adjustment, which is why the IRS tells you to keep adequate records for both systems.^[3] Second, the adjustment vanishes entirely when the shares are sold in the same tax year they were bought.^[3] A same year sale and a long hold are therefore two different tax events, not two versions of one. The AMT exemption and the income level at which it phases out are set separately for each tax year, so an identical exercise can cost materially different amounts in two adjacent years. Sizing the exercise against that year's numbers is the real work, and our tax planning team models it before the exercise rather than at filing.

Two clocks run at the same time and you have to beat both of them. The IRS sets the test as holding "until the end of the later of the 1-year period after the stock was transferred to you or the 2-year period after the option was granted."^[4] Clear both and the sale is a qualifying disposition taxed as capital gain. Sell a day short on either one and it is a disqualifying disposition. There is one narrow escape: you are still treated as meeting the test if you sold to comply with conflict of interest requirements.^[4]

A disqualifying disposition is specific rather than punitive. On a gain, the ordinary income is capped at the amount by which the share value at exercise exceeded the option price, and every dollar above that stays capital gain.^[5] On a loss there is no ordinary income at all and the result is simply a capital loss.^[5]

Form 3921 is the ISO paper trail and it arrives after the exercise year has closed. If you exercised an ISO during 2025 you should receive it, or an equivalent statement, for each transfer made during that year. "The corporation must send or provide you with the form by January 31, 2026."^[6] The IRS adds one instruction: keep the information for your records.^[6]

Treat it as a filing input rather than mail to be shelved. The exercise price and the value on the exercise date drive both the AMT adjustment for the exercise year and the character of the gain whenever you eventually sell, and the higher AMT basis it documents can matter on a sale several years out. Reconstructing an exercise price from memory is exactly how a disqualifying disposition gets miscoded on a return. Getting those figures onto the right lines is individual tax return preparation work.

An NSO is the simpler instrument and the more expensive one. Most nonstatutory options have no readily determinable value at grant, so nothing happens on the grant date; at exercise you include the market value of the shares received, less the amount you paid.^[7] That spread is compensation rather than investment return, so it carries income tax withholding and payroll tax in the year you exercise, whether or not you sell a single share.

The reporting is precise. Your employer reports the spread in box 12 of Form W-2 with code V, and also includes it in boxes 1, 3 and 5, so it feeds wages, Social Security up to the wage base, and Medicare.^[8] The practical trap is cash: withholding at the flat supplemental rate is often well short of what a large exercise actually costs a high earner, and the gap surfaces as an underpayment months later. Anyone balancing an exercise against other income that carries no withholding should read the quarterly estimated tax guide before the exercise date, not after it.

Because for options granted on or after January 1, 2014, the basis information reported on Form 1099-B will not reflect any amount you already included in income at grant or exercise.^[9] The broker reports what you paid for the shares. The compensation element that already ran through your Form W-2 is missing from that figure, so a return filed straight off the brokerage statement taxes the same dollars twice.

The IRS is direct about whose problem this is: making the appropriate adjustments to the reported basis is your responsibility, and the adjustment is made by completing Form 8949.^[9] For options granted before that date the reported basis may or may not reflect the income, so it still has to be checked rather than assumed.^[9] The identical mismatch shows up on RSU sales, where the vesting date value already taxed as wages is the missing piece of basis. When a large sale lifts total investment income, a separate surtax can apply on top of the capital gain; see the net investment income tax guide.

An RSU has no exercise price and no exercise decision, so the one variable an option holder controls is gone. Under the restricted property rule you do not include the value in income while the shares are nontransferable or subject to a substantial risk of forfeiture; once the property becomes substantially vested you include its fair market value, minus anything you paid for it, in income for that year.^[10] Your holding period for those shares begins at that same moment, not on the grant date.^[10]

That second rule decides the character of everything that happens next. Shares sold within a year of vesting throw off short term gain taxed at ordinary rates no matter how many years ago the RSU was granted. It also explains why a sell to cover executed on the vesting date produces almost no gain or loss: the sale price and the freshly reset basis are nearly the same number. One more detail the restricted property rule settles quietly: while property is still unvested, any income it throws off, including dividends, is additional compensation to you in the year you receive it.^[10]

Generally no, and the reason is structural rather than procedural. The restricted property rules do let you choose to include the value of the property in income in the year it is transferred to you, rather than the year it becomes substantially vested.^[10] That choice attaches to property you already hold. An RSU is a contractual promise until settlement, so there is usually no transferred property to elect on.

Restricted stock awards, which founders and very early employees more often receive, are the opposite case, and the election there runs on a short and unforgiving deadline with no relief for a late filing. The mechanics, the risks and the common failure modes are covered in the Section 83(b) election guide. Read the IRS caution precisely: "You can't make this choice for a statutory or nonstatutory stock option."^[10] It rules out electing on the option itself, not on stock, so shares taken by exercising early, while they remain nontransferable or subject to a substantial risk of forfeiture, are restricted property in their own right.

None of these are exotic. They are what happens when the grant documents, the payroll reporting and the brokerage statement get read separately instead of together, usually in April, usually by someone seeing them for the first time. Reconciling the three before an exercise or a sale is where the money is, and that is what our advisory solutions work looks like for equity holders. Partners, consultants and other high earners who hold awards alongside self employment income can start from our professional services tax help page.