When your company goes public, your equity compensation becomes taxable income overnight. The tax hit depends entirely on which securities you hold: restricted stock units (RSUs), incentive stock options (ISOs), or non-qualified stock options (NSOs).
RSUs trigger immediate tax liability when they vest. The IRS counts the fair market value at vesting as ordinary income, taxed at your full marginal rate. If your employer grants you $500,000 worth of RSUs that vest on IPO day, you owe income tax on the entire amount that year, regardless of whether you sell shares.
ISOs offer preferential treatment if you meet holding requirements. You pay no tax when the option vests or when you exercise it. Tax comes only when you sell the shares. If you hold the stock for at least two years from the grant date and one year from exercise, you qualify for long-term capital gains rates, typically 15 or 20 percent for high earners. Sell earlier and you lose this benefit, triggering ordinary income tax on the gain between exercise price and sale price.
NSOs follow a different path. You owe ordinary income tax on the spread between the exercise price and the stock's fair market value when you exercise the option. This happens before you sell any shares. Exercise 10,000 options at a $2 strike price when the stock trades at $50, and you have $480,000 in ordinary income to report immediately.
The concentration risk matters too. Suddenly owning a massive amount of one company's stock creates portfolio imbalance. Many employees use IPO proceeds to diversify, selling portions of their holdings to rebalance into index funds or other assets.
Tax-loss harvesting strategies become available afterward. If some shares decline in value, you can sell them at a loss to offset other gains and reduce your tax bill in future years.