RSUs and stock options: the decisions that cost the most.
Restricted stock units, options, and purchase plans are taxed on completely different schedules. Most of the expensive mistakes come from treating them alike.
Equity compensation is where high earners most often lose real money to a decision they didn't realize they were making. Not through bad luck. Through defaults: a withholding rate accepted, an exercise deferred, shares left invested after they vested, meaning the day they stopped being a promise and became genuinely yours.
The instruments are taxed on genuinely different schedules. Treating them as one thing called "my equity" is the root of most of it.
The short answer. Restricted stock is a cash bonus paid in shares, so holding it is a fresh decision to buy your employer's stock. Options are two separate decisions, and incentive options carry a tax trap if you hold after exercising. Set a selling rule in advance and follow it.
| Instrument | When the tax arrives | What catches people |
|---|---|---|
| Restricted stock units | At vest, on the full value, as ordinary income | Withholding is often below your real marginal rate |
| Incentive stock options | At exercise for alternative minimum tax, at sale otherwise | Exercising and holding can create tax with no cash received |
| Non-qualified stock options | At exercise, on the spread, as ordinary income | Needing cash to exercise before there is anything to sell |
| Employee stock purchase plan | Split between ordinary income and capital gain | Treatment turns on holding periods and plan terms |
Restricted stock is a cash bonus paid in shares.
Restricted stock units, usually shortened to RSUs, are the simplest and most misunderstood. Your employer promises you shares, and on a set date they vest, meaning they become yours. At that moment the full value counts as ordinary income and is taxed, whether you sell the shares or not. You've been paid a bonus and it arrived as stock.
Two consequences follow.
Holding vested shares is a fresh investment decision. You paid full ordinary income tax on that value. Keeping the shares is exactly the same as taking a cash bonus and using every dollar to buy your employer's stock. Very few people would do that deliberately, and a great many do it by not selling.
The withholding is frequently too low. Many plans withhold at a flat supplemental rate below the top marginal bracket. If your income is above that rate, the shortfall isn't visible until you file, and for a large vest it can be a substantial surprise. Check the rate your plan uses against your actual marginal rate and plan for the gap rather than discovering it.
Options are two decisions, not one.
An option gives you the right to buy at a set price. Exercising and selling are separate acts with separate consequences, and the type determines what happens.
Non-qualified options. The difference between the exercise price and the market value at exercise is ordinary income, taxed at exercise. Any later movement is a capital gain or loss from that point.
Incentive stock options. No ordinary income at exercise. Hold the shares long enough after both grant and exercise and the entire gain can qualify for long term capital gains treatment. That's the attraction, and it comes with a specific trap.
The trap that catches people with incentive options.
Exercising incentive stock options and holding the shares creates income for alternative minimum tax purposes, even though no regular tax is due and no cash has changed hands.
The failure mode is brutal in its logic. You exercise, hold for the favorable treatment, and the share price then falls. You owe tax calculated on a value the shares no longer have, and you may have to sell into weakness or find cash elsewhere to pay it.
Anyone holding incentive options should model that consequence before exercising, not after. There's usually an exercise amount that stays under the threshold, and finding it each year is ordinary planning rather than anything exotic. The calculation runs through Form 6251, and the IRS covers option treatment generally in Topic 427.
Employee stock purchase plans.
These let you buy at a discount, often with a lookback that prices from the lower of two dates. The discount alone frequently makes participation worthwhile.
The tax treatment depends on how long you hold and how the plan is structured, splitting the gain between ordinary income and capital gain in ways that reward holding. Publication 525 is where the IRS sets out how these plans are taxed. Whether that reward justifies the added concentration is a separate question, and for most people participating fully and selling promptly is the cleaner answer.
The concentration problem underneath all of it.
Add up vested shares, unvested grants, unexercised options, the purchase plan, and any employer stock in your retirement account. The total is often far larger than people realize. Where the surplus should go instead is the subject of what to do after maxing out your 401(k).
Then note that your salary, your bonus, your future grants, and possibly your industry reputation depend on the same company.
That's not a diversified position with a side of employment. It's one bet held several ways. The framework for unwinding it is in what to do when one stock is too much of your portfolio.
Deciding when to sell.
The useful approach removes the decision from the moment.
Set a target and a schedule in advance. Decide what percentage of your net worth you're willing to hold in company stock, then sell on a defined cadence to stay there. A rule made in a calm month survives a volatile one.
Default to selling restricted stock at vest. Make holding the exception that requires a reason. This single reframing prevents most of the accumulation.
Use a trading plan if you're an insider. A pre-arranged, documented schedule lets you sell during periods you otherwise couldn't, and removes the appearance of timing.
Know your windows and restrictions. Blackout periods, holding requirements, and company policy all constrain the calendar. Plan around them rather than into them.
Nothing here sits on its own.
A large vest or exercise interacts with your bracket, your capital gains rate, the Medicare surcharge two years later, and any Roth conversion you were planning. See tax planning.
Equity compensation is one of the few areas where the difference between planning and reacting is measurable in a single year rather than over decades. It's also one where the deadlines are real: grants expire, windows close, and elections have filing deadlines measured in days. That's the argument in which money decisions get more expensive the longer you wait.
Before the next vest or exercise.
- What withholding rate does my plan use, and what is my actual marginal rate?
- What percentage of my net worth is in this one company, counting everything?
- For incentive options, what is the alternative minimum tax consequence of the exercise I'm considering?
- What is my written rule for selling, and am I following it?
- What else is happening in my income this year that this will interact with?
No two compensation packages are alike, and the right answer depends on your plan documents as much as the tax code. If a vest or exercise is coming, let's talk before it rather than after.
Cosmos Wealth doesn't provide tax or legal advice, and nothing here is a recommendation regarding your equity or any particular security. Tax treatment depends on your plan documents, your filing situation, and current statute. Work with your CPA before exercising or making any election.
Common questions.
- Are RSUs taxed when they vest or when I sell?
- At vest. The full market value of the shares is ordinary income in the year they vest, whether or not you sell, and any movement after that is a capital gain or loss from that point. This is why holding vested shares is best understood as a fresh decision to buy your employer's stock with a cash bonus, rather than as leaving something alone.
- Why do I owe more tax in April after a large vest?
- Because statutory withholding on supplemental wages is frequently below the marginal rate a high earner actually pays. The shares were withheld at one rate and taxed at a higher one, and the gap arrives with the return. It is entirely predictable and worth estimating before the vest rather than discovering afterwards.
- What is the trap with incentive stock options?
- Exercising and holding can create alternative minimum tax on the difference between the exercise price and the market value, even though you sold nothing and received no cash. People have owed substantial tax on shares that later fell. There is usually an exercise amount each year that stays under the threshold, and finding it is ordinary planning rather than anything exotic.
- How are employee stock purchase plan shares taxed?
- It depends how long you hold them and how the plan is structured, with the gain split between ordinary income and capital gain in ways that reward holding longer. The discount itself is generally ordinary income. Read your own plan documents, because terms vary more than people expect.
- How should I decide when to sell?
- By deciding in advance. A rule set before a vest, and followed, beats a judgement made while watching the price. The reason is not tax: it is that your career and your net worth already depend on the same company, and every vest quietly increases that overlap without you choosing it.
