We will explain the four most common types in this article in plain English, with simple examples, so you can read your paperwork with confidence.
Difference Between RSUs, ISOs, ESPPs, and ESOPs
RSUs are company shares you're given for free once they vest. ISOs are options to buy shares at a fixed price with tax perks. ESPPs let you buy company stock at a discount through payroll. ESOPs are retirement plans that hold company stock for you. Each one is taxed differently.
Let's look at each type of equity compensation in detail.
What Are RSUs (Restricted Stock Units)?
RSUs are the simplest form of equity compensation. Your company promises to give you shares after you meet a vesting schedule, usually over a set number of years. You don't pay anything to receive them, and once they vest, they're yours.
RSU Example
You're granted 400 restricted stock units that vest over 4 years, so 100 vest each year.
If the stock is $50 when 100 vest, that's $5,000, taxed as ordinary income that year, just like a salary.
Cliff Vesting and Your Vesting Schedule
Many RSU grants have a one-year cliff, meaning nothing vests until you've stayed 12 months. After the cliff, shares usually vest monthly or quarterly. Leave before the cliff, and you typically walk away with nothing.
What Are ISOs (Incentive Stock Options)?
ISOs give you the right to buy company shares at a fixed strike price, no matter how high the stock climbs. They're popular at startups because they can be very tax-friendly.
ISO Example
Your strike price is $10. You exercise 1,000 shares when the stock is worth $30, locking in a $20-per-share paper gain and paying no regular income tax at that moment.
ISOs and the Alternative Minimum Tax (AMT)
The catch: that $20,000 paper gain can trigger the alternative minimum tax, even though you haven't sold anything. If you hold the shares long enough (one year after exercise, two after grant), your profit is taxed at lower capital gains rates. Non-qualified stock options (NSOs) don't get this perk and are taxed as income at exercise.
What Are ESPPs (Employee Stock Purchase Plans)?
An ESPP lets you buy your company's stock at a discount, often up to 15% off, through automatic payroll deductions. Many plans add a "lookback" that uses the lower price from the start or end of the period.
ESPP Example
The stock is $20, and your plan gives a 15% discount, so you buy at $17 and are instantly up $3 per share.
Sell right away, and that discount is taxed as income; hold longer, and part may qualify for capital gains.
Fair Market Value, Strike Price, and When to Sell
Comparing the fair market value to what you actually paid shows your real gain. Deciding when to sell vested shares is part tax math, part risk, because holding too much of one company's stock is risky, even when it's your own employer.
What Are ESOPs (Employee Stock Ownership Plans)?
An ESOP is the odd one out: it's a retirement plan that invests mainly in your employer's stock. The company contributes shares to a trust for you, and you owe no tax until you take a distribution, usually when you leave or retire.
ESOP Example
Your employer adds $4,000 of shares to your ESOP account this year. You pay nothing now; tax applies later when you cash out, often rolled into an IRA.
(Note: some startups loosely call their option pool an "ESOP," meaning an Employee Stock Option Plan, which is a different thing entirely.)
Frequently Asked Questions
Are RSUs taxed when they vest or when I sell?
Restricted stock units are taxed as ordinary income the moment they vest, based on the share price that day. If you later sell for more, the extra profit is taxed again as a capital gain. So most people face two separate tax events.
What is the alternative minimum tax (AMT) on ISOs?
When you exercise incentive stock options, the difference between the strike price and the fair market value is a "paper gain." Even without selling, that gain can push you into the alternative minimum tax. Holding the shares long enough can lower your overall tax on the eventual sale.
Is an ESPP worth it?
For most employees, yes, because buying company stock at a 15% discount is an instant gain. The main risks are tying too much money to one employer and the tax owed on the discount. Selling soon after purchase is a common, lower-risk approach.
What's the difference between an ESOP and stock options?
An employee stock ownership plan is a retirement account funded with employer stock, taxed only when you take a distribution. Stock options, like ISOs, give you the right to buy shares yourself at a set price. They serve very different purposes.
What is an 83(b) election?
An 83(b) election lets you pay tax on certain equity at grant instead of at vesting, which can save money if the stock rises. It's most relevant for restricted stock and early exercised options, and it must be filed within 30 days. A tax advisor can confirm whether it fits your situation.