What They Are
A non-qualified stock option (“NQSO”) is the right to purchase employer stock for a stated price for a specified period of time. NQSOs constitute actual ownership of shares and offer more flexibility than Incentive Stock Options (“ISO”) in terms of how they may be exercised and who may receive them. Unlike ISOs, which may only be issued to employees, NQSOs may be issued to non-employees as well (vendors, board of directors, etc.). NQSOs result in additional taxable income to the employee at the time that they are exercised, and result in taxable gain or loss to the taxpayer when the stock purchased through exercise is sold.
What to Know
The grant of an NQSO does not result in taxable income to the grantee. However, when the option is exercised, the recipient must report the spread (difference between exercise price and fair market value (“FMV”) of the stock) as compensation. If the recipient is an employee this income will be reported as wages on his or her Form W-2 from the employer for the year of exercise, and will be subject to federal income and FICA / Medicare tax withholding. If the recipient is a non-employee, the income will be reported on Form 1099-MISC.
The sale of the stock after an option is exercised is then reportable as capital gain or loss. The FMV on the exercise date becomes the purchase price or cost basis of the shares for purposes of determining gain or loss. If the shares are held for at least one year after exercise, the proceeds constitute long term capital gain or loss to the taxpayer. If the shares are sold within one year or less from the exercise date, the proceeds constitute short term capital gain or loss to the taxpayer.
Contact Hone Maxwell LLP today with questions about NQSOs and related tax planning.