Restricted Stock Units vs. Stock Options: Critical Tax Differences You Need to Know

Equity compensation has become an increasingly important component of total compensation packages, particularly in technology, finance, and other high-growth sectors. Two of the most common forms of equity compensation are Restricted Stock Units (RSUs) and Stock Options. While both provide employees with potential ownership in their company, they function very differently from a tax perspective.

This article breaks down the key tax implications of each, helping you make more informed decisions about your equity compensation.

Restricted Stock Units (RSUs): The Basics

RSUs represent a company's promise to give you shares of stock upon completion of a vesting schedule. Unlike stock options, RSUs always have value as long as the company's stock has value.

Tax Treatment of RSUs

When Granted: No tax consequences occur when RSUs are initially granted.

When Vested: This is the critical tax event for RSUs. When your RSUs vest:

- The fair market value (FMV) of the shares on the vesting date is considered ordinary income

- This amount appears on your W-2 and is subject to federal income tax, state income tax, Social Security, and Medicare taxes

- Your employer typically withholds taxes at vesting, often by selling a portion of your shares ("sell to cover")

When Sold: If you continue to hold the shares after vesting, any subsequent appreciation or depreciation is treated as capital gain or loss:

• If held for less than one year after vesting: Short-term capital gains (taxed at ordinary income rates)

• If held for more than one year after vesting: Long-term capital gains (preferential tax rates, typically 15% or 20% depending on your income bracket)

Example:

You receive 1,000 RSUs that vest after three years. On the vesting date, the stock is worth $50 per share.

- $50,000 ($50 × 1,000) is reported as ordinary income

- If you sell immediately, there's no additional gain or loss

- If you hold and later sell at $70 per share, the $20,000 appreciation would be capital gain

Stock Options: The Basics

Stock options provide the right, but not the obligation, to purchase company stock at a predetermined price (the "strike price" or "exercise price") for a specific period.

Types of Stock Options

1. Non-Qualified Stock Options (NSOs): The most common type, with relatively straightforward tax treatment.

2. Incentive Stock Options (ISOs): These offer potential tax advantages but come with more complex tax considerations and holding requirements.

Tax Treatment of Non-Qualified Stock Options (NSOs)

When Granted: Generally no tax impact if the option is granted at fair market value.

When Vested: No immediate tax consequences when options vest.

When Exercised: This is the primary tax event for NSOs.

• The "spread" (difference between the fair market value at exercise and the strike price) is taxed as ordinary income

• This amount appears on your W-2 and is subject to federal income tax, state income tax, Social Security, and Medicare taxes

• Unlike RSUs, tax withholding may not automatically occur, potentially creating a cash flow issue

When Sold: After exercise, any additional appreciation is treated as capital gain or loss:

• If held for less than one year after exercise: Short-term capital gain

• If held for more than one year after exercise: Long-term capital gain

Example:

You receive options to purchase 1,000 shares at $25 per share. Two years later, you exercise when the stock is worth $75 per share.

• $50,000 ($50 spread × 1,000 shares) is reported as ordinary income at exercise

• If you later sell at $100 per share, the additional $25,000 would be capital gain

Tax Treatment of Incentive Stock Options (ISOs)

ISOs offer potential tax advantages but come with more complex rules:

When Granted: No tax impact.

When Vested: No tax impact.

When Exercised: 

• No regular income tax is triggered (but the spread is an Alternative Minimum Tax (AMT) adjustment)

• The AMT calculation may result in additional tax liability in the year of exercise

• This can create significant and sometimes unexpected tax consequences

When Sold: Taxation depends on whether you meet special holding requirements:

Qualifying Disposition: If you hold the shares for at least 1 year after exercise AND 2 years after the grant date

• The entire gain (from original strike price to final sale price) is treated as long-term capital gain

• This is the most favorable tax treatment possible

Disqualifying Disposition: If you don't meet the holding requirements

The spread at exercise is taxed as ordinary income

Any additional gain is capital gain

Example:

You receive ISOs to purchase 1,000 shares at $25. You exercise when the stock is worth $75 and sell two years later (meeting holding requirements) at $100.

• The entire $75,000 gain ($100 - $25 × 1,000) is treated as long-term capital gain

• Without the holding requirements, $50,000 would have been ordinary income

Key Tax Differences: RSUs vs. Stock Options

Factor	RSUs	Stock Options
Tax Timing	Taxed at vesting	Taxed at exercise (NSOs) or sale (ISOs)
Tax Control	Limited control over timing	Greater control over when to recognize income
AMT Impact	No AMT concerns	Potential significant AMT impact with ISOs
Cash Required	None; shares are delivered	Cash needed to exercise and potentially pay taxes
Under water Risk	Always have value if stock has value	Can become worthless if stock price falls below strike price

Strategic Tax Planning Considerations

For RSUs:

1. Tax Withholding: Understand your company's withholding method (sell-to-cover, cash payment, etc.)

2. 83(b) Election: Generally not available for RSUs (except in rare circumstances)

3. Vesting Acceleration: Be prepared for tax consequences if vesting accelerates due to corporate events

4. Diversification: Consider selling some vested shares to diversify, as you've already paid taxes

For Stock Options:

1. Exercise Timing: Consider your outlook on the company and your personal tax situation

2. AMT Planning: For ISOs, model potential AMT impact before exercising

3. Early Exercise: Some plans allow exercise before vesting, potentially starting the long-term capital gains clock earlier

4. Cash Management: Plan for the cash needed to exercise and pay associated taxes

5. ISO Holding Periods: Carefully track holding periods to qualify for preferential tax treatment

Conclusion

While RSUs offer simplicity and guaranteed value, stock options provide greater flexibility and potential tax advantages. The optimal strategy depends on your financial situation, risk tolerance, and view of the company's prospects.

Given the complexity and significant financial implications, consulting with a tax professional who specializes in equity compensation is highly recommended before making major decisions about your RSUs or stock options.

Remember that tax laws change frequently, and this article reflects current tax treatment as of March 2025. Always confirm current tax rules before making decisions about your equity compensation.