Capital Gains Tax
Definition
Tax on the profit from selling an asset. Short-term capital gains (held less than 1 year) are taxed at your ordinary income rate (22-37%). Long-term capital gains (held more than 1 year) are taxed at preferential rates (0%, 15%, or 20% depending on income). For equity, the holding period starts at exercise (for options) or at vesting (for RSUs).
Real-World Example
You exercise ISOs at $2 strike when FMV is $5, then sell a year later at $20. The $3/share gain from exercise (strike to FMV at exercise) qualifies for long-term capital gains if holding period requirements are met. The $15/share gain from exercise FMV to sale price is also long-term capital gains. Total tax rate: ~15-20% instead of 22-37%.
Common Mistake
Selling shares immediately after exercise and expecting long-term capital gains rates. The holding period starts at exercise, not at grant. For ISOs to get favorable treatment, you must hold shares for 1 year after exercise AND 2 years after grant date.
Why It Matters
The difference between short-term and long-term capital gains can be 15-20% of your total profit. On a $200,000 gain, that is $30,000-$40,000. Timing your sales around the 1-year holding period can save significant money.
Related Terms
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