Equity Compensation: RSUs, ISOs, & ESPPs

Three letters decide whether your stock compensation is a windfall or a tax bill: RSU, ISO, ESPP. They are taxed at different moments, by different rules, and the one that catches people arrives before any cash does.

Last verified 2026-07-21

RSUs: you already paid the tax

Restricted stock units become ordinary income on the day they vest, valued at that day's price. Your employer reports it as wages and payroll withholds against it, exactly as though they had paid you cash and you had immediately bought the stock.

That last framing is the useful one. Your cost basis is the vest-date price, so at the moment of vesting there is no gain and selling triggers no additional tax. Selling that day is tax-neutral, not tax-expensive — which is the opposite of what most people assume.

So holding vested RSUs is not 'leaving it alone'. It is an active decision to buy your employer's stock with after-tax money you now control, while your salary, your bonus and your next promotion already depend on the same company. Most people would never choose that concentration deliberately; they arrive at it by not deciding.

ISOs and the tax on money you don't have

Incentive stock options let you buy shares at a fixed strike price. Exercise them and you pay nothing in ordinary income tax — which is the attraction, and also where the trap is set.

The spread between the strike price and the market value at exercise is an adjustment for the alternative minimum tax. You can owe real cash on a paper gain, in a year where you sold nothing and received nothing. If the share price then falls before you sell, the AMT bill does not fall with it. People were bankrupted this way after the dot-com crash.

To reach long-term capital gains treatment, the shares must be held more than two years from grant and more than one year from exercise. That holding period is what makes ISOs valuable, and it is also what forces you to carry the price risk to get there. Both facts have to be true at once when you decide.

ESPPs and the lookback

An employee stock purchase plan lets you buy company stock at a discount through payroll deduction. Under a Section 423 qualifying plan the discount can be up to 15%.

Many plans add a lookback, which is where the real value sits: the discount applies to the lower of the price at the start of the offering period and the price at the end. If the stock rose over the period, you buy at a discount to the old, lower price.

The discount is close to free money, but only until the shares land in your account — from that moment they are ordinary single-stock exposure to the company that already pays you. Selling promptly captures the discount and takes the concentration off the table; holding is again a fresh decision to invest in your employer.