Stock Awards vs. ISOs vs. NSOs

Because the differences are so nuanced, what follows is a summary of the taxes on restricted stock awards, ISOs, and NSOs, from an employee’s point of view.

• Restricted stock awards. Assuming vesting, you pay full taxes early with the 83(b) or at vesting:

  • At grant:

    • if 83(b) election filed, ordinary tax on FMV

    • none otherwise

  • At vesting:

    • none if 83(b) election filed

    • ordinary tax on FMV of vested portion otherwise

  • At sale:

    • long-term capital gains tax on gain if held for 1 year past when taken into income

    • ordinary tax otherwise (including immediate sale)

• NSOs. You pay full taxes at exercise, and the sale is like any investment gain:

  • At grant and vesting:

    • no tax if granted at (or above) FMV

  • At exercise:

    • ordinary income tax on the amount by which the FMV of the shares received exceeds the exercise price

    • income and employment tax withholding on paycheck

  • At sale:

    • long-term capital gains tax on gain if held for 1 year past exercise

    • short-term capital gains tax (ordinary income tax rates) otherwise (this includes immediate sale at exercise)

• ISOs. You might pay less tax at exercise, but it’s complicated:

  • At grant and vesting:

    • no tax if granted at (or above) FMV

  • At exercise:

    • AMT tax event on the bargain element

    • no ordinary or capital gains tax

    • no income or employment tax withholding on paycheck

  • At sale:

    • long-term capital gains tax if held for 1 year past exercise and 2 years past grant date

    • short-term capital gains tax (ordinary income tax rates) otherwise (this includes immediate sale at exercise)

Mary Russell, a lawyer who specializes in equity compensation, recommends each form of equity be used at the appropriate time in private companies: restricted stock awards for the earliest stage of a startup, stock options with longer exercise windows for the early to mid stage, and RSUs for the later stages.*

If you relish tax complexity, you can learn more from:

• The Tax Topics coverage of ISOs and NSOs from the IRS

• Joe Wallin’s posts on the Startup Law Blog, “Top 6 Reasons To Grant NQOs Over ISOs” and “Incentive Stock Options vs. Nonqualified Stock Options”

• Investopedia’s post “Get the Most Out of Employee Stock Options”

• EquityZen’s summary of the topic, “Understanding Equity Compensation And What It Means For Startup Employees”