- Stock: Actual shares of a company.
- Basis: Price purchased at. (or price when you received it as income)
- Proceeds: Price sold at
- RSU: A restrictive stock unit. A sort of “option” that is released into stock at a time determined by the
company who granted them.
- Some RSUs may be released into stock before an IPO.
- Others are done sometime between IPO and IPO lock-up expiry.
- NQSO: Non-qualified stock option. A call option granting the right, but not obligation, to purchase stock at
a given strike price. You have the right to determine when you exercise the option.
- ISO: Incentive stock option. An NQSO with special tax treatment (described below)
- FMV: Fair market value. Before IPO, this is determined by a third-party. Afterwards, it is the publicly
- Ordinary income: Wage income for the purposes of this document
- Capital gain: Difference between proceeds and basis at stock sale. Generally a taxable event on the seller
of the stock.
Calculate your taxes HERE.
You may be subject to both federal and state income taxes at various events. Generally, both systems are
progressive in that as your income rises, you pay a higher percent tax (your “bracket”) on your marginal
income. State rules are very state-specific - as a plurality of people going through an IPO are in California, I only cite that state's tax code.
You can read about the brackets and mechanics here. The short story is that
you pay taxes when you sell on the capital gains (difference between current price and issued price) on stock
are taxed as follows:
- stock held <= one year
- ordinary tax rate
- Incur additional net
investment income tax of 3.8% if you earn over a threshold ($200k single, $250k married). Note that
“earn” includes the proceeds of the stock sale.
Qualified Small Business Stock (QSBS)
If you were rather early into the company, you may be eligible
for no federal capital gains (you’ll still owe state if relevant!) You should know if your stock is QSBS
eligible - this is out of scope of this document.
California does not treat capital gains differently from income. So capital gains are just added to your income
and taxed at the appropriate marginal rate.
When an RSU share is released, the following occurs:
- Receive a single stock share with basis at current FMV
- Ordinary income increased by FMV (i.e. you pay ordinary income taxes on FMV income)
Generally speaking, the company withholds RSUs upon release to uses the withheld value to pay your taxes (under
standard withholding rules, which might differ from the actual taxes you owe on release).
Anything federally taxable is state taxable.
Note that if you have changed states since receiving your RSUs, two states may have rights to your income:
- State you currently reside/work in
- State that you were residing/working in when you received the RSU.
See California’s guide.
When you exercise an NQSO:
- Pay the NQSO’s strike price
- Ordinary income increased by FMV less strike price.
- Receive a single stock share with basis at current FMV.
Generally speaking, your company will require you to pay both the strike and the tax withholding for the increase
NSQO ordinary income has similar tax jurisdiction rules as RSUs.
ISOs are similar to NQSOs. However, if you don't sell the stock until at least 2 years after your initial grant AND a year after exercising, you receive
favorable tax treatment (deferral of paying taxes and move income being long-term capital gain):
- Pay the NQSO’s strike price
- No income adjustment
- Receive a single stock share with basis at strike price.
WARNING: the Alternative Minimum Tax treats ISOs similarly to NQSOs (ordinary income increases), so tread
carefully — exercising may increase your taxes. I recommend reading this guide.
- Brokers tend to have incorrect basis information on shares received from option exercises, reporting the
stock basis to both you and the IRS as the option strike price, not the FMV when you exercised. To avoid
double-paying tax (ordinary income on FMV less strike and later capital gains on FMV less strike), you’ll
need to file your tax forms carefully.
- Your company likely underwithholds RSUs on release, especially at IPO. Be prepared for a large federal tax
bill at the end of the year and potentially a state one (check the calculator to see what you might owe).
- To avoid tax penalties, you may need to make estimated payments or raise your tax withholding.
harbor rules might protect you from needing to pay estimated payments.
- CA offers no safe harbor for
taxpayers earning over $1M in a given year. To avoid penalties, you must pay at least the correct amount by Dec 31.
- As discussed in stock
tax minimization, capital gains can be transferred to others by gifting/donating, but ordinary income
cannot. There is very little you can do to minimize tax impact from an RSU release and the best you can do
with NQSOs is to consider exercising them in a year you don’t have a large RSU release.