A restricted stock unit (RSU) is a promise to deliver company shares, or their cash value, once vesting conditions are met. The recipient pays nothing and is taxed on the shares’ value when they are delivered. A stock option is the right to buy shares at a fixed exercise price, so it is only worth something if the stock rises above that price, and its tax treatment depends on whether it is an incentive stock option (ISO) or a nonqualified stock option (NSO).
Founders deciding how to compensate a team, and employees comparing offer letters, often treat RSUs and options as interchangeable. They are not. The choice affects risk, taxes, cash flow, and dilution for both sides.
What Is an RSU?
An RSU is a contractual right to receive stock in the future. Until the units vest and settle, the holder does not own shares, cannot vote them, and usually receives no dividends. Vesting is typically time-based, such as four years with a one-year cliff.
Private companies usually use double-trigger RSUs. Units must satisfy both a service requirement and a liquidity event, such as an IPO or acquisition, before they settle. Because shares are not delivered until there is a market to sell them, employees are not taxed on illiquid stock they cannot sell. Double-trigger RSUs commonly expire if no liquidity event occurs within a set number of years.
What Is a Stock Option?
A stock option gives the holder the right, but not the obligation, to buy a set number of shares at a fixed exercise (strike) price for a limited time, usually up to ten years. Options vest over time, and the holder decides when to exercise and pay. If the stock never rises above the exercise price, the option is “underwater” and may expire worthless.
Private companies should set the exercise price at no less than fair market value on the grant date, typically supported by an independent Section 409A valuation. Discounted options can trigger significant tax penalties for the holder under Section 409A.
Key Differences at a Glance
- What you receive: RSUs deliver shares (or cash) at settlement. Options give a right to buy shares.
- Cost to the holder: RSUs require no purchase. Options require paying the exercise price.
- Value if the stock falls: RSUs keep some value as long as the stock is worth anything. Options can become worthless.
- Timing of tax: RSUs are taxed at settlement. NSOs are taxed at exercise. ISOs are generally taxed at sale, with possible AMT at exercise.
- Control over timing: RSU tax timing is set by the vesting and settlement schedule. Option holders choose when to exercise.
- 83(b) election: Not available for RSUs. Available for options that are exercised early into unvested stock.
- Typical use: RSUs are common at later-stage and public companies. Options are common at early-stage startups.
How RSUs Are Taxed
RSUs are taxed as ordinary income when the shares are delivered, based on their fair market value at that time. For employees, that income appears on the W-2 and is subject to withholding. Any later change in value is a capital gain or loss when the shares are sold, with the holding period starting at settlement.
A common misconception is that RSU holders can accelerate taxation with an 83(b) election. They cannot. An 83(b) election applies to restricted stock, meaning actual shares transferred subject to vesting. An RSU is only a promise to deliver shares later, so there is nothing to make the election on. If early taxation at a low value is the goal, the company would need to grant restricted stock instead. Our article on the benefits of making an 83(b) election explains how that works.
How Stock Options Are Taxed
Nonqualified stock options (NSOs): No tax at grant or vesting. At exercise, the spread between fair market value and the exercise price is ordinary income, and employees are subject to withholding. Later appreciation is capital gain.
Incentive stock options (ISOs): ISOs can receive more favorable treatment, but only for employees and only if strict rules are met:
- No regular income tax at exercise, but the spread is an adjustment for the alternative minimum tax (AMT), which can create a tax bill without any cash from a sale
- To get long-term capital gain treatment on the full gain, shares must be held at least two years from grant and one year from exercise; an earlier sale is a disqualifying disposition taxed partly as ordinary income
- Only $100,000 of ISOs (measured by grant-date value) can first become exercisable in any calendar year; the excess is treated as NSOs
- Options must generally be exercised within three months after employment ends to keep ISO status
Early Exercise and the 83(b) Election for Options
Some companies let option holders exercise before vesting. The holder receives restricted stock that remains subject to the vesting schedule and can file an 83(b) election within 30 days of exercise. When the exercise price equals fair market value, the election can result in little or no immediate income, and appreciation after that point may be capital gain. For ISOs, the election matters mainly for AMT. Early exercise requires paying cash up front for stock that could lose value or be forfeited, so it suits some holders better than others.
The Company’s Perspective
- Dilution: Each RSU delivers a full share, so companies usually grant fewer RSUs than options for similar value. Options only dilute when exercised.
- Cash and withholding: At RSU settlement, the company must withhold taxes. Before an IPO, there may be no market to sell shares to cover withholding, so the company may need to withhold shares and pay the taxes in cash.
- Valuation: Options require a defensible 409A valuation for each grant.
- Acceleration: Both awards can include single- or double-trigger acceleration on an acquisition. See our article on single-trigger acceleration.
- QSBS: Shares acquired through option exercise or RSU settlement may qualify for the qualified small business stock exclusion if requirements are met, with the holding period starting when the shares are acquired.
The Takeaway
RSUs offer more certain value and simpler mechanics but less control over tax timing. Options offer more upside at a low strike price but carry exercise costs, expiration risk, and, for ISOs, AMT exposure. Early-stage companies often favor options. Later-stage companies, whose share price makes options less attractive, often move to RSUs. Either way, the plan documents and grant agreements should match the tax treatment everyone expects.
Frequently Asked Questions
Can I make an 83(b) election on RSUs?
No. An 83(b) election applies only to property actually transferred subject to vesting, such as restricted stock or early-exercised options. RSUs are taxed when the shares are delivered.
Are RSUs or stock options better for employees?
It depends on the company’s stage and the employee’s risk tolerance. RSUs keep value even if the stock price falls. Options can be worth more if the company grows substantially from a low exercise price.
Why do private companies use double-trigger RSUs?
Double-trigger RSUs settle only after both a service requirement and a liquidity event are met. This keeps employees from owing tax on shares they cannot yet sell.
What happens to my ISOs if I leave the company?
Vested options usually must be exercised within a period set by the plan, often three months. Options exercised more than three months after employment ends lose ISO status and are treated as NSOs.
How Sutter Law Can Help
Sutter Law helps companies design equity plans, choose between RSUs and options, and draft grant agreements as part of our startup law practice. We coordinate with your tax advisors on the tax issues. If you are setting up an equity plan or reviewing an offer, contact us for a free consultation.
This article is general information, not legal advice. Reading it does not create an attorney-client relationship.
