Taxes on equity

Author:

Spencer Kimbro, Esq.

|

Read time:

9 minutes

Published date:

1 April 2025

Having a solid understanding of how equity is taxed will help you make smart decisions as you earn equity, exercise your options, and sell your shares.
Keeping track of tax obligations isn’t most people’s idea of fun, but if you’re earning equity, you need to know what types of tax you’ll owe—and when you’ll need to pay them.
This article will run through the basics of equity taxation and help you determine whether your shares qualify for any preferential treatment—usually in the form of lower tax rates. We’ll also walk you through some steps to avoid the common mistake of paying the same tax twice on exercised options.

Important note: While we’re here to help you understand how taxes on stocks work, we aren’t giving tax advice in this article. You should definitely check in with your own tax advisor.

What triggers taxes on equity?

Two taxes generally apply to employee equity earnings: ordinary income tax and capital gains tax. Typically, you’ll owe income tax on your equity in the tax years during which you acquire shares. Capital gains tax comes into play when you sell your shares. (A third tax, the alternative minimum tax (AMT), may also apply to certain equity earners.)
Three major milestones can trigger a tax liability: equity vesting, exercising your options, and selling your shares.

1. Vesting restricted stock

Vesting refers to the process of earning an asset as you meet certain conditions. Usually, these conditions are milestone-based or time-based—like completing a specific project or remaining an employee at your company for a defined amount of time.
With stock options, you vest the right, or option, to purchase your shares at a defined price (the “ strike price”), which is set by the company in your award letter. When you vest restricted stock, such as restricted stock units (RSU) or restricted stock awards (RSA), you take ownership of your shares as they vest.

Stock award vesting can either be single-triggered or double-triggered. Single-trigger awards require that you meet just one condition for vesting; typically, it’s an amount of time that must elapse from the date of the award. Double-trigger vesting requires that a second condition be met; usually, this is a liquidity event—such as a company IPO, acquisition, or secondary offering—that enables you to sell vested shares.

When you vest restricted stock, it triggers ordinary income tax on the fair market value (FMV) of the shares on the vesting date. This income tax is due by the filing of your tax return for the related calendar year. If you hold RSAs, you have the option to file an 83(b) election, which lets you pay income tax on your shares in the year you are granted the award.

2. Exercising your options

Unlike RSUs, stock options, including incentive stock options (ISO) and non-qualifying stock options (NSO), must be exercised for you to acquire the stock. Exercising an option means buying the shares at the strike price.
If you’re exercising NSOs, you will have to pay income tax on the difference, or spread, between the exercise price and the fair market value (FMV) of the shares at the time of exercise. This spread counts as ordinary income.
For ISOs, the spread between the strike price and FMV at time of exercise could subject you to the alternative minimum tax (AMT) for that tax year.
When exercising your options, consider that many companies require former employees to exercise their shares during a post-termination exercise window, usually 90 days following an employee’s departure.
By helping private companies organize regular liquidity events for current shareholders to sell their equity, Carta Liquidity makes it easier for employees to overcome difficulties imposed by the post-termination exercise window.

3. Selling your shares

You may owe ordinary income tax or capital gains tax when you sell your stock. The amount you’ll pay in capital gains depends on the type of equity you hold.

Ways you may be able to pay less in taxes on your equity upon sale

The qualified small business stock (QSBS) exemption

If you hold qualified small business stock (QSBS), you may be entitled to a reduced capital gains rate for federal taxes on the sale of your stock—possibly as low as 0%.
To take advantage of QSBS benefits, you need to meet two basic criteria:

1. The company that issued you stock must have been a qualifying small business at the time you acquired your shares.
2. You’ve held your stock for at least five years since the acquisition date.

83(b) elections

If your equity plan allows early exercise, you can pay taxes on your shares at the time of the early exercise, as opposed to at the time of vesting, by making an 83(b) election.
There are three principal reasons to make an 83(b) election:

1. You expect the fair market value of the stock to increase between grant date and vest date of your shares.
2. You want to start the holding period for capital gains treatment upon eventual sale.
3. It is crucial that the shareholder file the 83(b) election directly with the IRS in a timely manner: Current rules require you to file no later than 30 days after the early exercise.

Qualifying dispositions on ISOs

If you hold ISOs, you might be able to save significantly on your tax liability at the point of sale by ensuring that you meet the criteria for a qualifying disposition.

Planning for the alternative minimum tax (AMT)

Another thing to consider when exercising your ISOs is the alternative minimum tax (AMT). To calculate your AMT, you make adjustments to your taxable income based on instructions set by the IRS on form 6251.

Stepping up your tax basis

One of the most common mistakes that taxpayers make is the failure to step up their tax basis when selling their equity.

Maximize your gains by planning ahead

It’s exciting to work for a company that offers equity compensation. However, many tax-related rules can be tricky to navigate. Always consult with a tax advisor before selling your shares.

Give your employees support in their tax decisions

Carta Equity Advisory helps employees navigate tax decisions about their equity ownership and taxes.

Author: Spencer Kimbro, Esq.

Spencer Kimbro is a member of the California State Bar. He is currently a Senior Tax Advisor on the Carta Equity Advisory Team. Prior to Carta, Spencer worked at Andersen Tax with a focus on high net worth individuals.