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RSUs vest and get taxed as ordinary income -- straightforward, no upfront cost. ISOs require cash to exercise but offer better tax treatment if you exercise early and hold long enough. Which is better depends on your company stage, cash position, and how much risk you are willing to carry while waiting on the outcome.
Sales reps at companies offering equity comp often do not think deeply about the differences until something forces it -- an IPO, a tax bill they did not expect, or a job change with options expiring in 90 days. By then, some of the most valuable decisions are already off the table. Understanding the comparison before the pressure hits is what gives you options.
For simplicity, RSUs win. For tax efficiency at early-stage companies with room to grow, ISOs win -- if you exercise when the spread is small and hold long enough to qualify for capital gains treatment. The answer depends on your specific situation.
Have equity comp and not sure which move to make?
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Let's TalkWhat Is the Difference Between an ISO and an RSU?
An RSU (Restricted Stock Unit) is a promise to deliver shares once a vesting schedule is met. You do not pay anything to receive RSUs -- the company grants them, they vest on a schedule, and when they vest you receive shares. No choice required.
An ISO (Incentive Stock Option) is a right to purchase shares at a fixed price -- the strike price -- set at the time of the grant. The option has no value if the stock price is at or below the strike. The value is in the potential to buy shares at a discount to the current market price. But you must pay the strike price to exercise the option and receive shares.
The core distinction: RSUs are passive (you receive shares automatically on vesting), ISOs require an active decision and upfront capital (you choose to exercise and pay the strike price).
RSUs are more common at public companies. ISOs are more common at pre-IPO startups where the current value is unclear and the strike price is set at or near the current 409A valuation. For an overview of equity compensation structures, the SEC's investor resources cover the major types in accessible language.
How Are RSUs Taxed?
When RSUs vest, the shares are treated as compensation. The fair market value of the shares on the vest date is ordinary income. Federal and state income taxes are owed on that amount at your marginal rate.
In practice, your company typically handles withholding one of two ways: they sell shares on your behalf to cover the tax liability (sell-to-cover), or they withhold a fixed percentage. The default withholding rate is often 22% -- the IRS supplemental wage rate -- which for many sales reps in higher brackets undershoots the actual liability, leaving a gap due at filing. This is the same withholding gap that affects commission income.
After vesting, the shares have a cost basis equal to their fair market value on the vest date. Any subsequent appreciation or decline is treated as capital gain or loss when you sell. Hold more than one year from vest and the gain is long-term capital gains. Hold less and it is short-term.
Example: 500 RSUs vest when the stock is at $80. You receive $40,000 of ordinary income, taxed at your marginal rate. If you hold and sell at $100 a year later, the $10,000 gain is long-term capital gains taxed at 15% (for most sales reps in the 22-24% bracket).
How Are ISOs Taxed?
ISOs have three potential tax events: exercise, qualifying disposition, and disqualifying disposition.
At exercise: no regular income tax. This is the main structural advantage of ISOs. However, the spread at exercise -- the difference between the fair market value and the strike price -- is added as a preference item for the Alternative Minimum Tax. If your AMT liability exceeds your regular tax liability, you pay the difference. Large spreads at exercise mean large AMT exposure even without selling a single share.
Qualifying disposition (the favorable outcome): you sell shares after holding them for more than 2 years from the grant date AND more than 1 year from the exercise date. The full gain from strike price to sale price is taxed as long-term capital gains -- typically 15% for most sales reps.
Disqualifying disposition (what most people end up doing): you sell before meeting both holding periods, or you do a same-day cashless exercise. The spread at exercise becomes ordinary income. Any additional gain is short-term or long-term capital gain depending on how long you held. This is essentially the same tax outcome as RSUs, minus the complexity.
The IRS provides detailed guidance on ISO tax treatment in Topic 427, and Publication 525 covers ISOs and other equity compensation in full detail.
Which Has Better Tax Treatment -- ISO or RSU?
ISOs win, but only under specific conditions.
For ISOs to produce better tax treatment, you need:
- A small spread at exercise (ideally near zero, achieved by exercising early when the 409A is low)
- Cash to exercise the options
- Willingness to hold the shares through both holding period clocks (2 years from grant, 1 year from exercise)
- A stock that actually appreciates
When those conditions are met, the math is clear. A rep in the 24% federal bracket who holds ISOs to a qualifying disposition pays 15% long-term capital gains instead of 24% ordinary income. On $100,000 of gain, that is $9,000 in tax savings.
RSUs win when:
- You need liquidity -- you cannot afford to pay the strike price to exercise ISOs
- The company is public and the stock is liquid
- You want simplicity -- RSUs require no decisions until vesting
- You are not in a position to absorb the risk of holding concentrated equity
For most sales reps at public companies: RSUs are the practical winner because they are liquid, automatic, and require no capital. For reps at early-stage pre-IPO companies with conviction in the outcome and cash to exercise: ISOs offer meaningfully better tax treatment.
What Should You Do When RSUs Vest?
Three decisions to make immediately on vest date.
First: cover the tax bill. The company's default withholding (22%) likely undershoots your marginal rate if you are in the 24% or higher bracket. Sell enough shares to cover the full tax liability at your actual rate, not just the withheld amount. If the default withholding was sufficient, skip this step.
Second: evaluate concentration risk. If you now own a significant amount of company stock in addition to your income from the same employer, you have double concentration -- your paycheck and your investment portfolio both depend on the same company's performance. A general rule: hold no more than 10-15% of your total portfolio in any single stock. If vested RSUs push you above that, sell down to the threshold.
Third: invest the proceeds. RSU proceeds sitting in cash lose purchasing power. If you are holding cash from RSU sales, direct it toward your existing investment plan -- taxable brokerage, additional retirement contributions, or other goals.
The one thing to avoid: holding RSU shares indefinitely because of psychological attachment to the company. Vested RSUs are cash you have already earned and been taxed on. Make the decision on whether to hold them the same way you would make a decision on any other investment.
When Does It Make Sense to Prioritize ISOs Over RSUs?
Three scenarios where ISOs are clearly the right move.
You are early at a pre-IPO company with a low 409A valuation. The strike price is $5, the 409A is $5, and you believe the company could be worth $50 in three to five years. Exercising now produces a near-zero spread and negligible AMT. If the company exits at $50, your long-term capital gain is $45 per share taxed at 15%. The same gain received as RSU income would be taxed at your ordinary income rate.
You have the cash to exercise without straining your finances. ISO exercise requires real money upfront. If exercising 10,000 options at $5 per share costs $50,000, make sure that $50,000 is not money you need for your emergency fund, tax reserves, or near-term obligations. The exercise should be discretionary capital you can afford to have locked up or lost.
You have a low-income year with AMT headroom. If you are between jobs, had a lower-commission year, or otherwise have a year where your income is below your usual level, the AMT exemption ($88,100 for single filers in 2026) may cover a meaningful portion of any spread. Use those years to exercise a larger block of options at lower tax cost.
When in doubt: run the numbers for your specific situation. The decision is not universal -- it depends on the current 409A, your income level, your AMT position, and your conviction in the company.
Frequently Asked Questions
ISO vs RSU -- which is better?
For simplicity and liquidity, RSUs. For long-term tax efficiency at early-stage companies, ISOs -- if you can exercise when the spread is small and hold through both qualifying disposition clocks. The right answer depends on your company stage, your cash position, and your willingness to carry concentrated equity risk while you wait.
Should I take ISO or RSU equity compensation?
If you are offered a choice, ISOs are typically better at early-stage companies with growth potential and low 409A valuations. At public companies, RSUs are often the more practical choice. The variable: ISOs require upfront capital and a commitment to holding periods that RSUs do not. If you cannot cover both, RSUs give you certainty.
How is RSU equity comp different from stock options?
RSUs are shares delivered on vest with no purchase required -- you receive them automatically and pay income tax on the value at vest. Stock options (including ISOs) require you to actively exercise by paying the strike price. Options have the potential for better tax treatment but require capital and holding period management. RSUs are simpler; options have higher upside if managed correctly.
ISO vs RSU tax treatment -- what is the difference?
RSU vesting is ordinary income taxed at your marginal rate. ISO exercise produces no regular income tax, but triggers an AMT preference item equal to the spread. If you meet the qualifying disposition holding periods (2 years from grant, 1 year from exercise), the full ISO gain is long-term capital gains. Disqualifying disposition -- selling too early -- produces ordinary income on the spread, similar to RSUs.
Which equity compensation should I choose?
Prioritize ISOs if: you are pre-IPO, the 409A is low relative to expected growth, you have cash to exercise, and you have the time horizon to meet qualifying disposition requirements. Prioritize RSUs if: you need liquidity, you are at a public company, or you cannot afford to tie up capital in options. When both are offered, a mix is often the practical answer.
When should I sell RSUs after vesting?
Make the sell decision based on portfolio concentration and tax efficiency -- not based on loyalty to the company. Cover any withholding gap at vest (sell enough shares to pay the full tax bill at your actual rate). Then evaluate how much company stock you already hold. If vested RSUs push your employer stock above 10-15% of your total portfolio, reduce the position to a reasonable concentration.
Are ISOs taxed as ordinary income?
Not if you meet the qualifying disposition requirements. A qualifying disposition -- holding shares more than 2 years from grant and more than 1 year from exercise -- results in the full gain being taxed as long-term capital gains. A disqualifying disposition -- selling too early -- converts the spread at exercise to ordinary income. The difference in tax rates can be 9-10+ percentage points depending on your bracket.
