ISO vs RSU: Key Differences, Taxes and a Worked Example for 2026

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

The main difference between ISOs and RSUs is who carries the risk and when the tax hits. An RSU is a promise of shares that are taxed as wages the day they vest, so it always has value as long as the stock is above zero. An incentive stock option (ISO) is the right to buy shares at a fixed strike price: it costs cash to exercise, it can expire worthless, and it can trigger the alternative minimum tax (AMT), but if you hold the shares long enough the whole gain can be taxed as a long-term capital gain instead of as pay.

For a two-income household in the Bay Area or Seattle where one parent has RSUs at a public company and the other has ISOs at a pre-IPO biotech or startup, the two grants need opposite handling. RSUs are mostly a withholding and concentration question. ISOs are an exercise-timing and cash question. Below are the rules for 2026, a worked example for a $900,000 household, and how the answer changes between California and Washington.

ISO vs RSU at a glance

A third type, the nonqualified stock option (NSO), sits between them: it has a strike price like an ISO but the spread is taxed as wages at exercise like an RSU. ISOs above the $100,000 annual limit (explained below) are treated as NSOs. If you are not sure what an RSU grant is worth today, our guide on how to calculate RSU value walks through it, and why RSUs have no strike price covers the most common confusion between the two.

How RSUs are taxed at vest in 2026

When RSUs vest and shares are delivered, the fair market value of the shares is wages on your W-2. There is no election to change that: a Section 83(b) election is not available for RSUs, because an RSU is not property until shares are delivered (Treas. Reg. §1.83-3(e)).

Your employer usually withholds federal tax at the optional 22% flat supplemental rate for 2026, rising to a mandatory 37% only on supplemental wages above $1,000,000 in the calendar year (IRS Publication 15). For a household whose top dollars fall in the 35% and 37% brackets, 22% is not enough, and the gap shows up in April. Medicare tax of 1.45% applies with no cap, plus the 0.9% Additional Medicare Tax once a married couple’s combined wages pass $250,000. In California, vest income is also subject to 1.3% SDI with no wage cap for 2026. The mechanics of covering the bill are in our comparison of withhold to cover vs sell to cover.

How ISOs are taxed: exercise, AMT and the holding periods

ISOs follow IRC §422. Nothing is taxed at grant. Nothing is taxed for regular federal income tax at exercise either (IRS Topic 427). The catch is the AMT: the spread at exercise (fair market value minus strike price, times shares) is added to your income for the AMT calculation on Form 6251. Your company reports the exercise to you on Form 3921.

What happens when you sell depends on how long you held the shares:

• Qualifying disposition. You sell more than 2 years after the grant date and more than 1 year after exercise. The entire gain over the strike price is long-term capital gain.
• Disqualifying disposition. You sell earlier. The spread at exercise (or the actual gain, if smaller) becomes ordinary income, and anything above that is capital gain. If the sale happens in the same calendar year as the exercise, no AMT adjustment is required for that year (IRS Publication 525).

Three more rules matter for this family:

• The $100,000 limit. If more than $100,000 of ISO stock (valued at grant-date fair market value) first becomes exercisable in one calendar year, the excess is treated as NSOs (IRC §422(d)).
• The 3-month rule. To keep ISO treatment, you generally must exercise within 3 months after leaving the company (IRC §422(a)(2)). Options exercised later are taxed as NSOs. This matters for a parent who leaves a startup to care for young children or take a new role.
• AMT credit. AMT paid because of an ISO exercise generally becomes a minimum tax credit (Form 8801) that you can use in later years when your regular tax exceeds your AMT. It is real money back, but the timing is uncertain.

Cashless and same-day exercises change the picture again; see tax on a cashless exercise of stock options.

Worked example: a $900,000 Bay Area household with both

Assumptions (illustrative, 2026 federal figures): married filing jointly, two children ages 4 and 7, $900,000 of combined W-2 wages including $200,000 of RSU vests at Parent A’s public tech company. Parent B works at a pre-IPO biotech and holds 20,000 vested ISOs with a $5 strike price; the current 409A value is $25 per share. The family takes the $32,200 standard deduction and has no other income.

The RSU side: a withholding gap of about $28,000

Taxable income is $900,000 minus $32,200, or $867,800. The top $200,000 of that (the RSU dollars) falls $99,100 in the 37% bracket and $100,900 in the 35% bracket, for about $71,982 of federal income tax. Withholding at 22% covers $44,000. The family should plan for roughly $28,000 more federal tax on the RSUs, plus California tax at marginal rates of 9.3% to 11.3% (2025 MFJ brackets) that may also be under-withheld. Medicare (2.35% including the additional tax) adds $4,700, and CA SDI adds $2,600.

The ISO side: how much can Parent B exercise without AMT?

Before any exercise, the family’s regular federal tax is $243,250.50 and its tentative AMT is about $207,854, so there is about $35,400 of room before AMT applies. Each $1 of ISO spread raises the AMT calculation by 28 cents at first, and by 42 cents once AMT income passes $1,000,000, because the AMT exemption ($140,200 for 2026) then phases out at 50 cents per dollar until it is gone at $1,280,400.

Exercising everything in 2026 would mean writing checks for about $215,860 (strike plus AMT) for shares the family cannot sell until a tender offer or IPO. Spreading the exercise over several years, using the no-AMT room each year, keeps the cash need near $29,400 a year. The trade-off: shares exercised later start their 1-year holding clock later, and if the 409A value rises, the future spread (and AMT) rises with it.

What the holding period is worth

Suppose the family exercises all 20,000 options and later sells at $25 in a qualifying disposition. The $400,000 gain is long-term capital gain: 20% federal plus the 3.8% net investment income tax, or about $95,200. In a disqualifying sale, the same $400,000 is ordinary income at 37%, or $148,000 federally. Holding saves about $52,800 of federal tax in this example, in exchange for carrying the risk of a private stock for at least a year after paying the AMT up front.

All figures are rounded and use 2026 federal tables from Rev. Proc. 2025-32. California has its own AMT calculation that also counts the ISO spread (Schedule P (540)), which the example does not include.

California vs Washington: where the answer changes

California. RSU vests are taxed as wages at rates up to 13.3% (2025 rates; the extra 1% applies to taxable income over $1,000,000) and carry 1.3% SDI for 2026. California has no lower rate for capital gains, so a qualifying ISO sale saves federal tax but not state tax: the gain is taxed by California at ordinary rates either way (FTB). The California AMT can also apply in the exercise year.

Washington. For 2026 there is no state income tax on RSU vests or on ISO spread at exercise. But a qualifying ISO sale produces a long-term capital gain, and Washington’s capital gains tax applies at 7% (9.9% on taxable gains over $1,000,000) above an annual standard deduction, which was $278,000 for 2025; the 2026 amount was not yet published (WA DOR). Using the 2025 deduction as a rough guide, the $400,000 gain above would owe about $8,540. In a disqualifying sale, the ordinary-income portion falls outside that tax. Washington has also enacted a 9.9% income tax on AGI over $1,000,000 starting in 2028 (WA DOR), so a family planning a multi-year exercise schedule should model 2028 and later differently.

Are options or RSUs better?

Neither is better in the abstract. RSUs are better when you want predictable value and no out-of-pocket cost: a $200,000 grant is worth something even if the stock falls 50%. ISOs can be worth far more if the company grows well past the strike price, and they are the main way early employees at startups share in that growth. They are worse if the company stalls, if you cannot afford to exercise, or if you leave and the 3-month window closes before you are ready.

For a family with young children and one stable public-company income, a reasonable frame is to treat the RSU income as part of the household’s base and the ISOs as a concentrated, illiquid bet that should be sized against what the family could lose without changing its plans. The broader concentration question is covered on our investment risk management page.

Decisions to make this year

1. Raise RSU withholding or make estimated payments to cover the gap between 22% and your real marginal rate.
2. Decide how much of the RSU stock to keep versus sell at vest, based on how much of your net worth is already in one employer.
3. Run an AMT projection before year-end to find this year’s no-AMT ISO room, and decide whether to exercise inside it, above it, or not at all.
4. Check your ISO grants against the $100,000 limit and your company’s post-termination exercise window.
5. Track each exercise lot’s grant date and exercise date so you know when a sale becomes qualifying.

Our tax management work starts with exactly this projection.

Common mistakes

• Assuming 22% withholding settles the RSU bill. At the 35% and 37% brackets it usually leaves a balance due.
• Exercising ISOs in December without an AMT estimate. A large exercise can create a five- or six-figure AMT bill on shares you cannot sell.
• Filing an 83(b) election for RSUs. It does not apply. 83(b) is for restricted stock and early-exercised options, within 30 days of the transfer.
• Forgetting the 3-month window after leaving a job. Missing it turns ISOs into NSOs, or lets them expire.
• Selling ISO shares one month early. A sale before both holding periods are met converts long-term gain into ordinary income.

What to write down for your kids

Equity compensation is one of the biggest money decisions many of these families make, and children rarely see the reasoning. A one-page note for each grant (why you exercised when you did, how much risk you were willing to carry, what you would do differently) turns a tax event into something your children can learn from later. As Kevin Luu puts it: “Your kids don’t need to inherit your portfolio. They need to inherit your decision-making process.” Our family governance work helps families keep those notes in a FamilyKnowledge® Library.

Frequently asked questions

Do RSUs trigger the AMT?

No. RSU income is taxed as wages for both regular tax and AMT at vest, so there is no AMT adjustment. RSU vests do raise your total income, though, which can push your AMT exemption into its phase-out and make an ISO exercise in the same year more expensive. That is why a family with both should model them together.

What happens to my ISOs if I leave the company?

Unvested options are usually forfeited. Vested ISOs must generally be exercised within 3 months of leaving to keep ISO tax treatment; some companies allow a longer window, but options exercised after 3 months are taxed as NSOs, with the spread taxed as wages. Check your plan document before you resign.

Can a private company give RSUs instead of options?

Yes. Late-stage private companies often grant RSUs that only fully vest after an IPO or sale, so no tax is due until that liquidity event. See our guide to RSUs at private companies.

Next step

Before you exercise any ISOs this year, get a projection that runs your RSU vests and the exercise through both the regular tax and the AMT, for federal and your state. If you want a second set of eyes, the Tax & Wealth Assessment covers that. This article is general education; the right move depends on your family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

Connect on LinkedIn →  · About Kevin