Non-Qualified Stock Option (NQSO / NSO)
An employer-granted stock option that creates ordinary income at exercise equal to the bargain element, with employer-side payroll tax withholding.
Detailed Explanation
NQSOs (also called NSOs) are taxed at exercise: the spread between fair market value and strike price is ordinary W-2 wages, subject to federal income, FICA, and Medicare withholding. Subsequent sale produces capital gain or loss measured against the exercise-date FMV. NQSOs do not have the holding-period requirements of ISOs and do not create AMT preferences, but they also do not qualify for the long-term capital gain treatment on the bargain element.
Key Points
- Taxed at exercise: the spread (FMV minus strike) is ordinary W-2 income with FICA and Medicare withholding.
- No tax at grant. No AMT preference, unlike ISOs.
- Exercise-date FMV becomes the basis; later gain or loss is capital, with the holding period starting at exercise.
- Sell-to-cover is common at exercise to fund the withholding.
- No qualifying holding period exists, so no part of the bargain element gets long-term capital gain treatment.
Practical Example
You exercise 5,000 NQSOs with a $4 strike when the stock is $24. The $20 spread times 5,000 = $100,000 of ordinary W-2 income, taxed with FICA and Medicare. Your basis in the shares is $24. If you later sell at $30, the $6 per share gain ($30,000) is capital gain, long-term if you held more than a year past exercise.
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Learn about Tax Planning & StrategyRelated Terms
Incentive Stock Option (ISO)
An employer-granted option to purchase company stock that, if held long enough, qualifies for preferential long-term capital gain treatment but creates Alternative Minimum Tax (AMT) on exercise.
Restricted Stock Unit (RSU)
A form of employer equity compensation that delivers shares (or cash equivalent) to an employee upon vesting, taxed as ordinary income at vesting.
Capital Gain
The profit realized from the sale of a capital asset such as stock, real estate, or cryptocurrency, taxed at preferential rates if held longer than one year.
Employee Stock Purchase Plan (ESPP)
A program letting employees buy company stock at a discount (typically 5 to 15 percent) through payroll deduction, with potentially favorable tax treatment if holding-period requirements are met.
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