Equity compensation is taxed at different events depending on the instrument: RSUs and NSOs create ordinary W-2 income at vesting or exercise, ISOs usually create no regular tax at exercise but can trigger AMT, and every one of these forms of comp creates a basis-tracking problem that shows up later on Form 8949. The single most expensive mistake in this area is the double-basis trap: the broker's 1099-B often understates cost basis, and if the preparer reports it as-is, the client pays tax twice on the same income, once as wages and once as capital gain.

What triggers ordinary income, and when

RSUs are taxed as compensation the year they vest, not the year they're granted. The fair market value of the shares on the vesting date gets added to Form W-2, Box 1, and the employer withholds on it like any other paycheck (IRS Publication 525, "Restricted Property"). There's no election to defer this for a standard RSU grant. If a client vested shares across four quarterly tranches in 2025, each tranche has its own FMV-at-vest amount and its own cost basis for the shares.

NSOs (nonqualified stock options) work the same way but at a different trigger: the bargain element, meaning the fair market value at exercise minus the strike price paid, is ordinary income in the year of exercise, also reported through W-2 wages (Pub 525, "Nonstatutory Stock Options"). Exercising and holding doesn't defer this. The ordinary income hits the day the option is exercised, regardless of whether the client sells the stock that day or five years later.

When ISOs create AMT exposure

ISOs (incentive stock options) create no regular income tax at exercise. But the bargain element is an AMT preference item, added back on Form 6251, Line 2i, "if you exercised an incentive stock option (ISO) and didn't dispose of the stock in the same year" (2025 Instructions for Form 6251). A client can owe a real AMT bill in April on stock they haven't sold and can't easily liquidate to pay the tax. This is the scenario that generates the angriest phone calls in Q1.

The default assumption for ISOs is: no regular tax at exercise, but run the AMT calculation regardless of how confident the client is that "nothing happened." If the client sells the shares in the same calendar year as exercise (a disqualifying disposition), the AMT preference generally doesn't apply and the transaction is taxed under regular rules instead, similar to an NSO. If the client holds the shares past the qualifying period, meaning more than two years from the grant date and more than one year from the exercise date, the eventual sale is taxed as long-term capital gain rather than ordinary income (Pub 525, "Incentive Stock Options"). Employers report ISO exercises on Form 3921, which is where the exercise date, grant date, and FMV data for this calculation should come from (2025 Instructions for Form 3921).

ESPP: qualifying vs. disqualifying disposition

Employee stock purchase plans split the same way ISOs do. A disqualifying disposition, meaning shares sold before meeting the plan's holding period, makes the full discount ordinary income in the year of sale. A qualifying disposition splits the gain: a smaller ordinary-income component tied to the original grant-date discount, and the rest taxed as capital gain (Pub 525, "Employee Stock Purchase Plan"). Employers report ESPP transfers on Form 3922, and that form is the source document for the purchase date, purchase price, and FMV needed to run either calculation correctly.

The double-basis trap: the actual CPA workflow

This is where most of the dollar-value errors live, and it is not a rare edge case. Brokers are required to report cost basis on Form 1099-B, but for equity comp shares, the broker-reported basis is frequently just the amount the client paid in cash (the strike price, the ESPP discount price, or $0 for RSUs). It does not include the ordinary income already taxed through payroll. If the preparer enters the 1099-B basis as-is, the client's capital gain on sale is overstated by the exact amount already taxed as wages, the same dollars get taxed twice, and the IRS eventually sends a CP2000 notice years later comparing the 1099-B to what was reported, sometimes flagging the UNDER-adjusted version as suspiciously low instead.

The fix is mechanical. The 2025 Instructions for Form 8949 direct preparers to report the 1099-B basis as shown in column (e), then make a correction in column (g) with the appropriate code in column (f), commonly code B when the reported basis is wrong. The adjustment increases basis by the amount already included in W-2 income from the vesting, exercise, or ESPP purchase event. The reviewer's job is to pull the vesting/exercise date from the equity plan statement or Form 3921/3922, confirm the W-2 income amount for that event, and verify the 8949 basis adjustment matches it dollar for dollar before the return goes out.

CPA review checklist

Pull four documents before touching the return: the W-2, the year-end equity plan statement (showing every vest/exercise/purchase event), the 1099-B, and Form 3921 or 3922 if ISOs or ESPP shares were involved. Match every sale on the 1099-B to a vesting or exercise event on the equity statement. For each match, confirm whether the broker-reported basis already includes the ordinary income component; if it doesn't, adjust on Form 8949. For ISOs held past year-end, run the AMT calculation regardless of the client's assumption that nothing is owed.

FAQs

Does the full sale price of RSU shares count as a capital gain? No. Only the appreciation between the vesting-date fair market value and the sale price is capital gain. The vesting-date value was already taxed as ordinary wage income and is included in the cost basis (IRS Pub 525, "Restricted Property," https://www.irs.gov/publications/p525).

When does an ISO exercise trigger AMT? When the client exercises an ISO and does not sell the stock in the same calendar year, the bargain element (FMV at exercise minus strike price) is added back on Form 6251, Line 2i. Selling in the same year as exercise generally avoids the AMT preference but taxes the spread as ordinary income instead (2025 Instructions for Form 6251, https://www.irs.gov/instructions/i6251).

What's the ISO holding period for long-term capital gain treatment? The client must hold the shares more than two years from the grant date and more than one year from the exercise date. Meeting both conditions makes the sale a qualifying disposition, taxed entirely as long-term capital gain (IRS Pub 525, https://www.irs.gov/publications/p525).

Why does the 1099-B basis need adjusting for equity comp sales? Because brokers often report only the cash the employee paid, not the amount already taxed as W-2 income at vesting or exercise. Reporting the unadjusted basis on Form 8949 double-counts that income as capital gain (2025 Instructions for Form 8949, column (g) adjustment, https://www.irs.gov/instructions/i8949).

What documents should a reviewer pull before preparing a return with equity comp? The W-2, the broker's year-end equity plan statement showing each vest/exercise/purchase, the 1099-B, and Form 3921 (ISO exercises) or Form 3922 (ESPP purchases) if applicable. These are the source documents for matching basis adjustments to actual taxed income.

Reviewing a batch of returns with RSU and ISO activity by hand is where basis-adjustment errors slip through fastest. [SignalsHQ] flags 1099-B and W-2 mismatches before they reach the client copy.