FAQs – Stock Options
Non-qualified stock options may be sold at any market price, either higher or lower than the grant price. While non-qualified stock options carry less favorable tax treatment for the holder than qualified stock options, they offer other benefits. Non-qualified stock options can be issue to anyone — employees, board members, vendors — whereas qualified stock options may only be issued to employees.
There are no limits on the total market value of stock that can be exercised by a given holder, while there are strict limitations on the total market value of incentive stock options that can be exercised in one calendar year. The biggest advantage for companies is that as long as withholding obligations are met, they can deduct the cost of granting non-qualified stock options as an operating expense.
- Topic No. Stock Options | Internal Revenue Service.
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These costs are equal to the gain declared by the holder, which he or she reports as ordinary income. The employee only pays income taxes on the compensation element once. When he decides to sell the stock, he is required to pay taxes on the gain. Thinking of taking advantage of your employee stock options?
Find out if these options are right for your portfolio.
Non-Qualified Stock Options: Basics Features and Taxation
Rebalancing is like a tune-up for your investments. Selling the shares typically requires that the shares be tradable on a public stock exchange, such as after a startup company has had its initial public offering IPO of stock or as with a mature company whose stock has been trading publicly for many years. Under some circumstances, you may be able to sell shares of private company stock. You will owe income tax once you exercise your non-qualified stock option. For this reason, many option holders sell at least enough shares when they exercise their options to pay the tax owed.
Another common approach is a same-day exercise and sale, in which all exercised shares are sold immediately once they are purchased. Once you exercise your non-qualified stock option, the difference between the stock price and the strike price is taxed as ordinary income.
This income is usually reported on your paystub. There are no tax consequences when you first receive your non-qualified stock option, only when you exercise your option. Also, while there are no direct alternative minimum tax AMT consequences to exercising a non-qualified stock option as there are for ISOs , higher reported income may subject you to AMT.
When you exercise your option and buy shares, your cost basis in those shares is the stock price on the day you exercised. When you later sell your shares, taxation follows the normal rules for gains and losses on investments.
How Are ISOs Taxed?
If you hold the shares for one year or more, any gain is taxed at the favorable long-term capital gains rates. If you hold the shares for less than one year, any gain is taxed at your ordinary income tax rates, which are usually higher. Some pre-IPO companies have stock option plans that allow option holders to exercise their stock options before they vest.
Early exercising private company stock options in conjunction with making a Section 83 b tax election can convert a large portion of taxable income from ordinary income into capital gain. Stock options usually last for a long period of time e.
Non-Qualified Stock Option (NSO) Definition
There are two types of stock options that you can offer to your employee: incentive stock options ISO and non-qualified stock options NQSO. This discussion will focus on non-qualified stock options. Unlike an incentive stock option ISO , which must meet certain requirements under Internal Revenue Code Section to achieve its tax-favored status, a non-qualified stock option NQSO is a stock option that either does not meet statutory requirements or specifically states that it is an NQSO. As a result, an NQSO plan is an extremely flexible form of employee compensation.
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Generally, if an option does not have a readily ascertainable FMV at the time it is granted to the employee, it is not treated as taxable income to the employee at the date of the grant. Instead, the option is treated as taxable income when the employee purchases the option shares.
The amount of taxable income is the difference between the FMV of the shares at the date of purchase and the option price the amount the employee pays for the shares.