You got an offer letter with equity. Maybe it says "10,000 stock options" or "200 RSUs vesting over four years." It feels like a big number. It might be. But between the grant and the money in your pocket, there's a tax event that catches a lot of people off guard.
Here's how equity compensation actually works, from grants to vesting to taxes, and what it does to your paycheck.
RSUs (Restricted Stock Units)
RSUs are the most common form of equity compensation at public companies. They work like this: your company grants you a number of shares that vest over a schedule, typically 25% per year over four years, or quarterly after a one-year cliff.
When RSUs vest, they become yours. And at that moment, the fair market value of the shares is treated as ordinary income, added to your W-2 just like salary. Your employer withholds taxes on the vesting event, usually by selling a portion of the shares to cover the tax bill.
The withholding problem: Most employers withhold at the federal supplemental rate of 22%. If your total income puts you in the 24% or 32% bracket, the 22% withholding isn't enough. You'll owe the difference at filing time. For a large RSU vest (say, $40,000 worth of shares) that gap can be $2,000–$4,000.
What to check on your pay stub: After an RSU vest, look for a line showing the shares vested as income and a corresponding tax withholding. If the withholding rate is 22% and your effective rate is higher, consider submitting an updated W-4 or making an estimated tax payment to cover the gap.
Stock Options: ISO vs NSO
NSOs (Non-Qualified Stock Options): When you exercise NSOs, the difference between the strike price (what you pay) and the fair market value (what the shares are worth) is taxed as ordinary income immediately. If your strike price is $5 and the stock is trading at $25, you owe income tax on $20 per share at exercise. This shows up on your W-2 and withholding is applied.
ISOs (Incentive Stock Options): ISOs get preferential tax treatment. Exercising them doesn't trigger ordinary income tax. But it can trigger the Alternative Minimum Tax (AMT), which is a parallel tax calculation that affects higher earners and people with large ISO exercises. The AMT "spread" (difference between strike price and FMV at exercise) is added to your AMT income. If this pushes your AMT liability above your regular tax, you owe the difference.
Many people exercise ISOs without understanding the AMT implications and are surprised by a five-figure tax bill the following April. If you're exercising a large number of ISOs, talk to a CPA before you do it.
Selling Shares: Capital Gains
When you sell shares, whether from vested RSUs or exercised options, selling them triggers capital gains tax. The rate depends on how long you held the shares after vesting or exercise:
| Holding Period | Tax Treatment | Rate |
|---|---|---|
| Under 1 year | Short-term capital gains | Your ordinary income rate |
| Over 1 year | Long-term capital gains | 0%, 15%, or 20% |
For RSUs, the holding period starts at vesting. For options, it starts at exercise. Holding for at least a year before selling can meaningfully reduce your tax rate, but it also means bearing the risk that the stock price drops.
What to Do
Use our Paycheck Calculator to model your base salary withholding. Then add your expected RSU vesting income to see if your current W-4 settings will withhold enough by year-end. If not, adjust now. It's much easier to increase withholding throughout the year than to come up with a lump sum in April.
Equity compensation can be life-changing money. But the gap between the grant number and the after-tax number is often 30–45% once federal, state, and FICA taxes are applied. Know your real number before you make plans around it.