RSU vs ISO vs NSO: How Equity Compensation Is Taxed in 2026

Equity compensation is where smart, well-paid people make expensive tax mistakes — usually by treating RSUs, ISOs, and NSOs as if they work the same way. They do not. One is taxed when it vests, one can be taxed twice (once for regular tax, once for the AMT), and one is taxed at exercise like a bonus. Get the category wrong and you can owe a six-figure tax bill on stock you never sold. This page lays the three side by side with 2026 numbers.

The Three Instruments at a Glance

RSUs: The Simple One

A restricted stock unit is a promise to deliver shares when they vest. There is nothing to "exercise." Per IRS Publication 525 (Taxable and Nontaxable Income), at vesting the fair market value of the delivered shares is ordinary compensation income, reported on your W-2 and subject to income tax, Social Security, and Medicare withholding.

Example: Priya's 1,000 RSUs vest when the stock is $80. She has $80,000 of ordinary income added to her W-2. Her employer typically sells ~22%–37% of the shares (the supplemental wage rate, often a flat 22% federal up to $1M of supplemental wages, 37% above) to cover withholding. Her cost basis in the remaining shares is $80/share. If she later sells at $110, the additional $30/share is a capital gain — long-term if held more than a year from vesting.

NSOs: Taxed Like a Bonus at Exercise

A non-qualified stock option is taxed under IRC §83. There is no tax at grant (for a normally structured option). At exercise, the spread — fair market value minus the strike price — is ordinary income, on your W-2, with FICA and income-tax withholding, exactly like a cash bonus.

Example: Marcus holds 5,000 NSOs with a $10 strike. He exercises when the stock is $46. Spread = ($46 − $10) × 5,000 = $180,000 of ordinary income reported on his W-2 in the year of exercise. His basis in the shares becomes $46. Sell at $46 same-day and there is no further gain; hold and sell later at $60 and the $14/share is capital gain (long-term if held >1 year from exercise). Use the bonus tax calculator to estimate the withholding hit on that $180,000 spread.

ISOs: The Complicated, Tax-Favored One

Incentive stock options are governed by IRC §422 and are the only one of the three with a genuine tax preference — but it comes with the Alternative Minimum Tax attached.

• At exercise — regular tax: nothing. The spread is not ordinary income for regular tax, and there is no FICA.
• At exercise — AMT: the spread (FMV − strike) is a positive AMT adjustment under IRC §56(b)(3). This is the part people miss.
• At sale — qualifying disposition: if you hold the shares more than 2 years from grant and more than 1 year from exercise, the entire gain over the strike price is long-term capital gain.
• At sale — disqualifying disposition: sell too early and the bargain element is converted back to ordinary income, like an NSO.

The AMT Math (2026 figures)

For 2026, per the IRS inflation adjustments (Rev. Proc. 2025-32), the AMT exemption is $90,100 for single filers and $140,200 for married filing jointly, with phase-outs beginning at $500,000 (single) and $1,000,000 (MFJ). AMT rates are 26% and 28%.

Example: Lena, single, exercises 4,000 ISOs at a $5 strike when the 409A/FMV is $55. She holds the shares (planning a qualifying disposition).

• Regular tax on exercise: $0.
• AMT preference: ($55 − $5) × 4,000 = $200,000 added to her AMT income.
• That $200,000 can push her into AMT for the year, generating an extra tax bill in the tens of thousands — on shares she has not sold and has received no cash from.

The AMT Credit

The AMT you pay on an ISO exercise is not necessarily lost. It generally creates a minimum tax credit (Form 8801) that you can use in later years when your regular tax exceeds your tentative AMT — effectively a timing difference rather than a permanent double tax, if the stock holds value and you have future regular-tax capacity to absorb the credit.

The 83(b) Election

An IRC §83(b) election applies to restricted stock or, importantly, to early-exercised options that are still subject to vesting. It lets you elect to be taxed now on the value at grant/early exercise (often near zero in an early-stage startup) instead of later as it vests at a much higher value.

Example: An early employee early-exercises options when FMV equals the strike, so the spread is $0. Filing an 83(b) within 30 days means $0 of ordinary income now, the holding-period clock starts immediately, and all future appreciation is capital gain. Skip the election and each vesting tranche is taxed as ordinary income at the then-higher FMV.

RSU vs ISO vs NSO — Side by Side

2026 long-term capital gains breakpoints (per Rev. Proc. 2025-32): the 15% rate starts above $49,450 taxable income for single filers ($98,900 MFJ) and the 20% rate starts above $545,500 single ($613,700 MFJ). High earners also face the 3.8% Net Investment Income Tax on the gain.

Common Mistakes to Avoid

• Assuming 22% RSU withholding is enough — at a 35–37% marginal rate it is not; expect an April balance.
• Exercising ISOs without modeling AMT — the preference can create a large cash tax bill on unsold, possibly illiquid stock.
• Treating an ISO disqualifying disposition as capital gain — selling before 2-years-grant / 1-year-exercise reverts the bargain element to ordinary income.
• Missing the 30-day 83(b) window — irreversible; no extensions exist.
• Forgetting state tax and NIIT — equity income is state-taxable where earned, and large gains attract the 3.8% NIIT; check your state calculator.

Tools to Help

Frequently Asked Questions