How Stock Income Is Taxed in the US (RSU, ESPP, Options)

# **How Stock Income Is Taxed in the US: RSUs, ESPPs, & Options**

Earning stock-based compensation is a major financial benefit. Understanding the tax rules is essential to maximizing its value. Here is a clear guide to how the IRS taxes three common types of equity compensation: Restricted Stock Units (RSUs), Employee Stock Purchase Plans (ESPPs), and Stock Options.

1. Restricted Stock Units (RSUs)

RSUs are company shares granted to you that vest (become yours) over time.

Taxation Timeline:

At Vesting: When your RSUs vest, the **fair market value (FMV) of the shares is taxed as ordinary income**. This amount is added to your W-2 wages, and taxes are typically withheld by your employer (at a flat supplemental rate of 22% or 37% if over $1 million). This is your **"grant price" or cost basis**.

When You Sell: Any subsequent gain or loss is taxed as capital gains.

• Held < 1 year after vesting:** Short-term capital gains (taxed at your ordinary income tax rate).
• Held > 1 year after vesting:** Long-term capital gains (taxed at preferential rates: 0%, 15%, or 20%).

Key Point: The main taxable event is at **vesting**. The value on that day becomes your earned income.

## **2. Employee Stock Purchase Plans (ESPPs)**

ESPPs allow you to purchase company stock at a discount, typically through payroll deductions.

Taxation Rules (Qualified "Section 423" Plans):

Taxes are typically due **only when you sell the shares**. The discount is treated as compensation, but its tax treatment depends on the **holding period** from the **offering date** and the **purchase date**.

*   **Qualified Disposition:**
   *   **Requirements:** Hold shares for **>2 years from offering date** AND **>1 year from purchase date**.
   *   **Taxation:** The discount is taxed as **ordinary income**, but the rest of the gain is taxed as **long-term capital gains**.

Disqualified Disposition:

Occurs when** you sell before meeting the qualified holding periods.
Taxation:** The discount (and any gain up to the market value at purchase) is taxed as **ordinary income**. Any remaining gain is taxed as a **short-term or long-term capital gain**, depending on how long you held the shares.

Key Point: For maximum tax advantage, aim for a **Qualified Disposition**. The discount is often the most significant taxable element.

3. Stock Options

Options give you the right to buy company stock at a fixed price (the "strike" or "exercise" price) in the future.

A. Incentive Stock Options (ISOs)

*   **At Exercise:** **No regular income tax** (but the "bargain element" may trigger the Alternative Minimum Tax (AMT)).
*   **At Sale:**
   *   **Qualifying Disposition:** Sell shares **>2 years from grant date** AND **>1 year from exercise date**. Profits are taxed entirely as **long-term capital gains**.
   *   **Disqualifying Disposition:** Sell before meeting the above periods. The "bargain element" at exercise is taxed as **ordinary income**; any additional gain is a capital gain.

B. Non-Qualified Stock Options (NSOs)

• At Exercise: The "bargain element" (FMV at exercise minus strike price) is taxed as ordinary income.
• At Sale: Any further gain (sale price minus FMV at exercise) is taxed as a capital gain (short- or long-term based on holding period from exercise).

Key Point: ISOs offer potential long-term capital gains treatment but come with AMT risk. NSOs are simpler but taxed as income upon exercise.

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## **Summary Table**

| Type          | First Taxable Event                     | Tax Treatment at First Event       | Upon Sale (If Held)                             |
|---------------|------------------------------------------|------------------------------------|--------------------------------------------------|
| **RSU**       | At Vesting                               | Ordinary Income                    | Capital Gains (ST or LT)                         |
| **ESPP**      | At Sale (usually)                        | Discount = Ordinary Income*        | Capital Gains (ST or LT)*                        |
| **ISO**       | At Sale (if qualifying) or Exercise (if AMT applies) | Potential AMT at Exercise          | LT Cap Gains (Qualifying) or Mix (Disqualifying) |
| **NSO**       | At Exercise                              | Ordinary Income                    | Capital Gains (ST or LT)                         |
| *Applies to Qualified ESPPs. Dispositions determine final treatment. | | | |

Strategic Considerations

1.  **Withholding May Not Be Enough:** RSU vesting is often under-withheld for high earners. Plan for a potential tax bill.
2.  **Timing Is Key:** For ISOs and ESPPs, holding periods directly impact your tax rate.
3.  **State Taxes:** Don't forget state-level taxation, which can vary significantly (e.g., California taxes ISOs at exercise).
4.  **AMT Planning:** If you exercise ISOs, consult a tax professional to model your AMT exposure.

Stock compensation can significantly impact your tax situation. Proactive planning with a specialist can help you minimize taxes and make strategic decisions about when to exercise and sell.

Need personalized guidance on your equity compensation?** The experts at Prestivo Tax LLC specialize in navigating the complexities of RSUs, ESPPs, and stock options to help you keep more of what you earn.