Hi,
Two people can own the same 10,000 shares, sell at the same price, and walk away with tax bills $31,700 apart. Nothing about the stock is different. The only difference is which clock they were on when they exercised – and whether anyone ran the numbers before they pressed the button.
RSUs, ISOs, NSOs and ESPP shares all sit in the same brokerage account and look like the same thing. They are taxed under four different sets of rules, and the right move for one is the wrong move for another.
Here’s how the savings work:
Single filer, $250,000 salary, 10,000 ISOs at a $5 strike, stock now at $25. That’s a $200,000 spread:
- Exercise and sell the same day: the whole $200,000 is ordinary income on your W-2. Federal tax on that spread is about $69,000.
- Exercise, hold past both clocks, sell later at the same $25: the whole $200,000 is long term capital gain. At 15% plus the 3.8% investment income tax, about $37,600. Roughly $31,700 less.
- The bill for waiting: exercising and holding makes that spread an AMT preference item. In the exercise year you’d owe about $44,600 of alternative minimum tax – in April, with no stock sold to pay it.
Most of that AMT comes back later as a credit. But you have to fund it first, and if the stock falls before you sell, you paid tax on a gain that never happened.
Everything is different for every instrument you hold:
- RSUs: taxed as ordinary income the day they vest, whether you sell or not. Your basis is already the vest price, so holding gives you no tax benefit at all.
- ISOs: no regular tax at exercise, but the spread hits AMT. Sell too early and the entire spread converts to ordinary income.
- NSOs: the spread is ordinary income the day you exercise, plus payroll tax. Everything after that is capital gain.
- ESPP: the discount is ordinary income either way. The holding period only decides how much of the rest is long term.
For ISOs, two clocks have to run out, both of them – more than 2 years from the grant date, and more than 1 year from the exercise date. Miss either one and you’re back to ordinary income rates on the full spread.
Two things people get wrong here: holding vested RSUs is not a tax strategy, it’s a concentration bet – you’d never take a $200,000 cash bonus and put all of it into your employer’s stock, but that’s exactly what holding does. And payroll withholds a flat 22% on RSU vests up to $1 million. If your marginal rate is 32% or 35%, a $200,000 vest leaves you roughly $26,000 short in April, plus an underpayment penalty.
Two things that stack on top:
- Ladder your ISO exercises across tax years. Exercise up to the AMT crossover point each year, pay no AMT, and start the one year clock on each tranche.
- Donate appreciated shares instead of cash. Held more than a year, you deduct the full market value and never pay the capital gain at all – which turns a concentrated position into a deduction.
One point here is cost basis. Brokers are required to report your basis on Form 1099-B, often doing so without the compensation element already taxed on your W-2. On RSU and ESPP sales that basis often comes through as the purchase price or as zero. If nobody corrects it on Form 8949, you pay tax twice on the same dollars. We find this on new client returns constantly, and it is amendable.
Don’t wait to amend, however – your tax refunds eventually expire.
Another point is timing. Exercising ISOs early in a calendar year gives you an escape hatch – if the stock drops, you can sell before year end and wipe out the AMT preference entirely. Exercise in December and that door is already closed.
If you’re holding RSUs, ISOs, NSOs or ESPP shares, reply to this email by Friday and we’ll schedule a free 15 minute call with our senior tax advisor to map out which decisions are yours to make before December 31.
Sincerely,
—
George Dimov, CPA
Licensed and Insured
(833) 829-1120 toll free
(212) 994-8081 Fax
www.dimovtax.com