ISO vs NSO vs RSU: What You Actually Own

Three equity types dominate tech compensation. They look similar in an offer letter. Their tax treatment is dramatically different.

ISOs: the interesting one

ISOs are the only equity type that can produce all long-term capital gains treatment. The tax savings on a $1M gain moving from 37% ordinary to 20% LTCG is $170K. But the qualifying rules are strict:

• Hold the shares at least 1 year from exercise date
• Hold at least 2 years from the grant date
• Both must be met before sale

Miss either holding requirement and the "disqualifying disposition" taxes the spread at exercise as ordinary income — same as an NSO would have been.

The AMT trap

If you exercise ISOs and hold past year-end, the spread between strike price and FMV at exercise counts as AMT income. For a pre-IPO employee exercising ISOs with a strike of $2 and a 409A of $20, that's $18/share of AMT income. On a 10,000-share exercise, that's $180,000 of AMT income — potentially $50K+ of AMT owed in April.

Two things to know:

• The AMT is recoverable via the AMT credit in future years. You pay now, you get it back later. But "later" means when your AMT is lower than your regular tax, which requires planning.
• The AMT exemption and phaseout matter enormously. For 2026 (approximate): exemption ~$89K single / $138K MFJ, phaseout begins ~$639K / ~$1.28M. Strategic exercise timing can spread income under the exemption.

Exercise-and-sell-same-day

This "cashless exercise" treats the ISO as a disqualifying disposition. You lose the potential LTCG on the spread but pay no AMT. Financially equivalent to an NSO. Often the right answer if you need liquidity or can't tolerate AMT.

NSOs: simple and predictable

Exercise triggers ordinary income on the spread (strike to FMV). From that moment, you hold stock with basis equal to FMV at exercise. Subsequent gain is capital gains. Simple, boring, no AMT, no complex holding rules — also no special tax benefit.

The question with NSOs is when to exercise. Early exercise (if allowed) locks in gains early, potentially at lower FMV, at the cost of putting your own capital at risk. Late exercise means paying ordinary income tax on whatever the stock is worth then.

RSUs: no choice required

At vest, the FMV of shares delivered is ordinary income — taxed automatically, with shares withheld to cover (at 22% supplemental). You end up holding actual shares with basis equal to their vest-date value. Any appreciation from there is capital gains; any decline is a capital loss.

The key planning question: sell at vest or hold?

• Selling at vest = instant diversification, no additional risk. Default recommendation from most advisors.
• Holding = betting your employer stock outperforms broad indices, while concentrated in a single ticker you're already economically exposed to (through salary).

Most tech workers hold by default, not decide to hold. That's the trap.