Resources

What Pre-IPO Employees Need to Know about RSU vs. ISO vs. NSO Taxes

Published on August 26, 2026

When you hold multiple types of employee equity, you’re juggling multiple tax treatments and timing. It can be tricky to keep straight. But understanding how your equity is taxed may help you evaluate planning strategies ahead of a liquidity event, like an initial public offering.

The most common forms of equity held by pre-IPO employees include restricted stock units (RSUs), incentive stock options (ISOs) and nonqualified stock options (NSOs). This guide will review the key features of each, how they’re taxed and what common mistakes to watch out for.

RSUs

Restricted stock units, or RSUs, are a promise from your employer to give you company shares, usually following a vesting schedule and other requirements. At pre-IPO companies, you may have single- or double-trigger RSUs. Single-trigger RSUs typically vest once you’ve been at the company for a certain length of time. Double-trigger RSUs must meet a second requirement in addition to the time-based one. Often, you won’t be fully vested in your RSUs until a specified event, such as the company reaching an IPO or acquisition.

How RSUs are taxed

RSUs can trigger taxes in two ways. The first occurs at vesting, when shares are transferred and taxed as income the way a cash bonus might be. The second is when shares are sold and capital gains (or losses) are realized. That can trigger capital gains taxes on the difference between the sale price and the cost basis, or the price of the shares on the vest date.

How RSU taxes work: an example

For example, say you have 20,000 RSUs that have met the time-based vesting trigger. A second vesting requirement is met when the company goes through an IPO. You have to wait to sell shares until your company’s lock-up agreement expires. A lock-up agreement prevents company insiders from selling shares for a set period of time, which is often six months.

At the IPO, if the share price opens at $25, you’d have $500,000 in supplemental income, which would be added to your W-2 and taxed at your marginal income tax rate.
At the time you sell, if the share price has increased to $28, yours would be worth $560,000. That means you’d have $60,000 in capital gains. If you sold within a year of the IPO date, your gains would be treated as short-term capital gains and be taxed at your marginal tax rate. If you sold your shares a year or more after the IPO, they’d be treated as long-term capital gains, and taxed at a lower rate (0%, 15% or 20%, depending on your tax bracket).

A note on tax rates

The tax rates discussed in this article are federal only, and they leave out two things that could add to your bill.

The net investment income tax adds 3.8% to some or all of your capital gains if your modified adjusted gross income is more than $200,000 (single) or $250,000 (married filing jointly). For higher earners selling a large amount of stock, it would likely apply to the full gain.
State income and capital gains taxes vary widely. You’ll need to plan for those tax bills, as well. Consider consulting with a financial or tax advisor who can help you understand the specific tax rates that could apply to your equity compensation.

Watch out for underwithholding

Employers often withhold taxes on newly vested RSUs, similar to how they withhold taxes on bonus income. One way this could happen is through a “sell to cover” arrangement. That means a portion of your vested shares are sold on the vesting date to cover the withholding. You’d receive fewer shares than your original grant promised, but, ideally, your taxes would be covered.

However, it’s possible — even common — to underwithhold with RSUs, which could leave you with a surprise tax bill. That’s because the IRS default tax withholding rate for supplemental income is 22%. (It’s 37% on any supplemental income above $1 million.) For tech employees going through an IPO, that rate may be too low, and you won’t withhold enough to cover what you owe.

You can avoid a surprise tax bill on your RSUs by modeling your income and tax liability in the year of the IPO and determining what your withholding rate should be. You’d need to adjust your withholding before the RSUs vest. Your company’s HR department or equity platform should be able to walk you through the steps to do that. Alternatively, you could plan to make quarterly estimated tax payments to cover the gap between your withholding and your estimated tax bill.

RSU tax strategies

We cover strategies for paying RSU taxes, as well as other wealth-building tips in the video below.

Stock options

Unlike RSUs, stock options are a type of equity compensation that allow you to purchase a set number of company shares at a specific price, called the strike price.

Incentive stock options, or ISOs, are a type of stock option granted only to employees. ISOs typically receive preferential tax treatment under certain circumstances, potentially allowing more of your gain to qualify for long-term capital gains rates. You may not owe taxes at the time you exercise (or purchase the shares) if you meet certain holding period requirements. Those include holding your shares at least one year from the exercise date and two years from the grant date.

ISO limits and NSOs

Additionally, only $100,000 worth of ISOs can become exercisable by an individual in a given year. For qualification purposes, the value of your shares is determined by the fair market value at the time they’re granted. That means if you have a grant worth $120,000, the first $100,000 will qualify for preferential tax treatment as ISOs. But the last $20,000 won’t — those shares would be considered nonqualified stock options, or NSOs.

NSOs don’t have the tax perks that ISOs do, so they have fewer restrictions. For example, they can be granted to outside service providers, including board members, advisors and consultants, as well as employees.

How ISOs and NSOs are taxed (plus how RSUs compare)

Stage	Restricted stock units (RSUs)	Incentive stock options (ISOs)	Nonqualified stock options (NSOs)
When they’re vested	The fair market value of your vested shares are treated as supplemental income and taxed at your ordinary income tax rate.	Vesting doesn’t trigger a taxable event. Stock options give you the choice to purchase company shares at a discount once the options vest, which means the shares don’t become yours until you exercise.	Vesting doesn’t trigger a taxable event. Stock options give you the choice to purchase company shares at a discount once the options vest, which means the shares don’t become yours until you exercise.
When they’re exercised	Not applicable.	Taxes are deferred until you sell your shares, though you may face alternative minimum tax (AMT).	The bargain element — which is the difference between the strike price and the market value of the shares at the time they’re exercised — is taxed as ordinary income when you exercise your options.
When they’re sold	You may owe capital gains tax when you sell. If you sell shares within a year of vesting, they’ll be treated as short-term capital gains, which are taxed at your ordinary income tax rate. If you sell shares a year or more after vesting, they’ll be treated as long-term capital gains and taxed at a lower rate.	Qualifying disposition: If you hold ISOs for at least a year from the exercise date and at least two years from the grant date, you’ll owe long-term capital gains taxes on the entire gain, from the strike price to the sale price. Disqualifying disposition: If you don’t meet holding requirements, you may owe ordinary income taxes on the bargain element and short- or long-term capital gains taxes on the capital gains.	You may owe capital gains tax when you sell. If you sell shares within a year of exercise, they’ll be treated as short-term capital gains, which are taxed at your ordinary income tax rate. If you sell shares a year or more after exercise, they’ll be treated as long-term capital gains and taxed at a lower rate.

Watch out for AMT

The primary tax perk of ISOs can turn into a tax surprise if you’re not planning for alternative minimum tax, or AMT. AMT is a parallel tax system and it’s calculated at the same time as the standard federal income tax. It has its own rates and rules, which determine how much you may owe in federal income taxes. If your tax bill is higher under the AMT system, you’d pay that amount instead of what you owe under the standard system.

The goal of AMT is to make high earners pay at least some income tax, which means you may lose tax breaks. For example, there is no standard deduction or state and local tax deduction under the AMT system. For ISOs, that also means the IRS treats the difference between the strike price and the fair market value of your ISOs as income when you exercise your options.

The goal isn’t necessarily to avoid AMT. But it should be in mind as you plan when to exercise your options, and how much to exercise at once. We cover some possible strategies in the video below.

Stock option tax strategies

Disclosures

NerdWallet Wealth Partners, LLC (“NWWP”) is an SEC-registered investment adviser. Registration as an investment adviser does not imply a certain level of skill or training, nor does it constitute an endorsement by any securities regulator.

The information, analysis, opinions, examples, and hypothetical scenarios presented herein are provided for general informational and educational purposes only and do not constitute investment, legal, tax, or accounting advice, or a recommendation to buy or sell any security or adopt any particular investment or tax strategy. This material does not take into account your individual financial circumstances, objectives, or needs and should not be relied upon as the basis for any investment or financial decision. Before taking any action, consult with your own qualified investment, legal, and tax professionals.

Any discussion of a potential initial public offering (“IPO”) or other liquidity event is based on publicly available information as of the date of publication. There can be no assurance that an IPO or other liquidity event will occur, or that it will occur on the timeline discussed.

Examples, illustrations, projections, and hypothetical scenarios are provided solely for educational purposes to demonstrate financial planning concepts. They are not intended to predict future events, investment performance, or financial outcomes. Actual results will vary based on individual circumstances, market conditions, tax laws, and other factors.

The tax treatment of equity compensation, including incentive stock options (ISOs), nonqualified stock options (NSOs), restricted stock units (RSUs), and the alternative minimum tax (AMT), is complex and depends on an individual’s specific circumstances. Readers should consult their own tax advisor regarding the tax consequences of any transaction involving equity compensation.

Past performance does not guarantee future results. All investing involves risk, including the possible loss of principal. The views expressed herein are subject to change at any time based on market or other conditions and are current only as of the date of publication.