Introduction

Understanding tax liability is crucial when it comes to understanding equity compensation. Taxes vary by award type, can significantly impact the value of your equity, and knowing what to expect can help you make informed decisions. Whether you're earning equity, exercising your options, or selling your shares, being aware of the tax implications may save you from unexpected tax bills and can help maximize your financial benefits. This article provides an overview of the basics of taxation on equity awards employees receive from their company or employer's stock plan. Please consult a qualified tax advisor about your specific tax situation.

Taxation overview

U.S. tax laws vary based on your stock award type and what you do with the shares of company stock you receive. The chart below provides a general overview of what taxes apply.

Award type	Grant	Vesting/Settlement	Exercise	Shares sold
ISO	None	None	None, but may be subject to AMT	Capital gains
NQO	None	None	Ordinary income* and FICA** tax	Capital gains
RSA with 83(b)	Ordinary income and FIA** tax	None	N/A	Capital gains
RSA without 83(b)	None	Ordinary income and FICA** tax	N/A	Capital gains
RSU	None	Ordinary income and FICA** tax	N/A	Capital gains

*Assuming that you filed an 83(b) if early exercise your options, which tells the IRS that you want to the entire income tax obligation to apply at the time of exercise, when the exercise price usually equals FMV, instead of at the time of vest.

**FICA includes Social Security (up to the annual maximum) and Medicare taxes.

Stock options

Tax liability with both ISOs and NQOs are not triggered until exercise, and each are treated differently, as explained below.

Non-qualified Stock Options (NQOs)

When an NQO is exercised, the difference between exercise price and the current fair market value (FMV), known as the spread, is reported as income on your W-2. You may be responsible for paying tax on this income to your employer, who in turns remits that tax to the taxing authorities.

Incentive Stock Options (ISOs)

Unlike NQOs, when ISOs are exercised the spread between the exercise price and the FMV at exercise is generally not subject to ordinary income tax. However, that spread may trigger Alternative Minimum Tax (AMT) when you file your taxes. See this article for additional details about AMT when exercising ISOs.

Early exercise and 83(b) filing

Generally, you can only exercise options once they have vested. With a typical four-year vesting schedule, the value of your stock could increase significantly, potentially resulting in a large tax liability if the FMV has risen by the time you choose to exercise. However, if your stock incentive plan allows for early exercise, you can purchase the shares before they fully vest. This could lead to a lower tax burden. By exercising early (and filing an 83(b), which is discussed below), you determine the income tax liability now at the current FMV for shares that will vest in the future, hopefully when the FMV will be higher. If the spread between the exercise price and the FMV is low at the time of early exercise, the overall amount you pay in taxes should be lower. This could also potentially reduce AMT exposure for ISOs if the spread is very small or no spread at all.

You will need to file an 83(b) election (also referred to as form 15620), with the IRS to lock in the potential lower tax liability with early exercising. If you choose not to file, the tax burden will be as if you never early exercised. See our article on filing for 83(b) for more information.

Short term and long-term capital gains

As with selling other assets, you may be subject to capital gains tax when you are able to sell the shares of company stock you own. Holding onto your shares for a longer amount of time, which is yet another benefit with early exercising options or filing an 83(b), can mean a more favorable long term capital gains tax rate.

For NQOs, the shares must be held for at least a year after exercising your NQOs.
For ISOs, the shares must be held for two years from the date your ISOs were granted, and one year after exercising your ISOs.

Restricted Stock (RSAs and RSUs)

Taxes and vesting

For restricted stock (including RSAs and RSUs issued under the plan), the tax liability starts when you own the shares. For RSAs, this typically is when the shares vest. RSUs will typically vest, or settle, through a single trigger (typically time-based) or a double trigger (an addition requirement of a liquidity event such as a sale or IPO) requirement on the award.

Restricted stock is considered income, which requires you to pay income withholding taxes to your employer. The taxable amount is calculated by subtracting the original purchase price, which may be $0, from the FMV, i.e., the spread.

83(b) filing

If RSAs are subject to vesting, filing an 83(b) with the IRS within 30 days of the grant allows you to lock in the income tax determination early, hopefully when the FMV is low. If no 83(b) is filed for RSAs subject to vesting, then ordinary income tax is owed at each vesting period, which could lead to a larger tax burden. Similar with early exercised options, filing the 83(b) for RSAs subject to vesting allows you to essentially accelerate the tax calculation to when the shares are obtained and as opposed to waiting for the future vesting date when the FMV, and therefore the spread, may be much higher. See this article for more information on filing the 83(b). An 83(b) election isn’t available for RSUs because share ownership under those awards doesn’t happen until the RSUs have fully vested, which means the income acceleration role of an 83(b) election doesn’t apply.

Filing an 83(b) may not be for everyone. If you file an 83(b) election but then leave the company before your RSAs have vested, you can’t get a refund of the income taxes paid when you purchased the shares. Similarly, if the stock's value decreases after you purchase it, resulting in a fair market value at vesting that is lower than at the time of the purchase, you can’t claim a loss deduction unless the shares are sold at the reduced value.

As a result of these risks, employees typically file an 83(b) election when they pay the full FMV to acquire RSAs since there is no spread and therefore no income tax, yet when employees purchase RSAs at a discount or are awarded them at no cost, they may determine that the filing of an 83(b) could lead to higher taxes than if the election was not filed. Regardless of which situation you are in, you may choose to consult a tax or financial advisor to help you decide if making an 83(b) election is right for you.

Capital gains

When selling restricted stock, shares that have been owned for more than a year are eligible to receive the long-term capital gains rate.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Fidelity Private Shares LLC provides cap table management and other administrative services to private companies and their equity compensation plans.

Fidelity Private Shares LLC

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