NSO
Non-qualified stock option · NQSO · Nonstatutory stock optionAn NSO is a non-qualified stock option: a right to buy company shares at a fixed strike price that does not meet the conditions for an incentive stock option. When it is exercised, the spread between the strike and the fair market value is ordinary income, taxed like wages in that year.
What is an NSO?
Any stock option that is not an ISO is an NSO. The name means it does not qualify for the special treatment in Section 422 of the US tax code, which is why the IRS calls it a nonstatutory option. A company can grant NSOs to anyone, including contractors, advisors and directors, and an ISO that stops qualifying becomes one: an exercise more than three months after leaving the company, or the part of a grant above the $100,000 per-year ISO limit.
The tax on an NSO arrives at exercise. Because an employee option, which can't be traded, has no readily ascertainable value of its own when granted, the tax code waits until it is exercised and then treats the spread, the value of the shares received less the amount paid, as compensation income.
After exercise the shares have a cost basis equal to the fair market value on the exercise date. A later sale is a capital gain or loss from that basis, long-term when the shares were held more than a year from the exercise date.
How an NSO works, with numbers
An employee holds 1,000 NSOs with a $2.00 strike and exercises them when the company's 409A is $5.00. The exercise costs $2,000, and the $3,000 spread is ordinary income that year, reported with wages.
The shares now have a basis of $5.00 each. Sold at $9.00 more than a year later, the remaining $4,000 is a long-term capital gain.
- FMV at exercise, per share
- $5.00
- Strike, per share
- − $2.00
- Spread per share
- $3.00
- Shares
- × 1,000
- Ordinary income at exercise
- $3,000
Why an NSO matters
An NSO exercise costs the strike in cash and creates taxable income at the same time, on shares that, at a private company, may not be sellable. The income is fixed on the exercise date; a later fall in the share price does not reduce it.
The spread on an NSO is taxed as compensation in the exercise year. Against an ISO, the tax arrives earlier, and there is no holding period to meet for the spread itself.
NSO in Taiga Finance
Taiga Finance labels each option grant ISO or NSO on its row. An NSO grant's drawer shows “Exercisable today” with the strike to exercise it and “Spread today” per share and on the exercisable shares, priced at the company's latest 409A or market price.
Logging an exercise records the date, the shares, the “Price paid / sh” and the “FMV that day / sh”, with the cost shown before it saves. An exercise on an ISO grant can be marked “Treated as” “NSO”, so a post-termination exercise is recorded as the NSO it has become. The exercise history keeps the price paid, the cost and the FMV then for each lot.
Equity compensation →Key takeaways: NSO
- An NSO is any stock option that does not qualify as an ISO. It can be granted to non-employees.
- The spread at exercise is ordinary income in that year.
- The shares' cost basis is the FMV on the exercise date; gain above it is a capital gain.
- An ISO exercised more than three months after leaving the company is taxed as an NSO.
Questions about NSO
What is an NSO?
A non-qualified stock option: the right to buy shares at a fixed strike, granted without the conditions of Section 422. The spread is taxed as ordinary income when the option is exercised, and the shares take the exercise-date FMV as their cost basis.
How is an NSO taxed compared with an ISO?
An NSO's spread is ordinary income in the year of exercise. An ISO's spread is not regular income at exercise but counts toward AMT, and a sale after the holding periods is a capital gain on the whole gain over the strike.
How is the NSO spread taxed at exercise?
As compensation income: the FMV of the shares on the exercise date minus the amount paid, times the shares exercised. A $3.00 spread on 1,000 shares is $3,000 of ordinary income that year.
Does Taiga Finance track NSO exercises?
Yes. An exercise logs against a vested option grant with its date, shares, price paid and the FMV that day, and shows its cost before it saves. The exercised shares count in Investments and net worth at the share of value the grant record is set to count.