What is a Non-Incentive Stock Option (NSO) and How Is It Taxed?

Sean O’Keefe
Sean O’Keefe

Jul 1, 2022

2 min read
What is a Non-Incentive Stock Option (NSO) and How Is It Taxed?

As startups are finding ways to attract top talent, stock options have become a common perk to offer monetary incentive and give employees a sense of pride and ownership in the company they work for.

Stock plans, including the non-incentive stock option (NSO), allow employees to purchase shares of the company at a set price (FMV) on specific dates to potentially maximize their earnings potential. However, every stock option comes with special tax considerations that employees need to understand.

If you have or are considering purchasing an NSO, here’s what you need to know about how it could affect your taxes (and overall wealth).

What is a Non-Incentive Stock Option (NSO)?

Also referred to as a non-qualified stock option, non-incentive stock options are employee-purchased stocks that require you to pay regular income tax (similar to your salary) on the difference between the fair market value (FMV) at grant date and the FMV at the time you exercise your options. Remember that the FMV changes at minimum annually when the 409A valuation is renewed.

For example, if the FMV is $1 per share and the current FMV is $10, you have income of $9 per share taxed at regular income tax rates.

Employees will have a deadline to exercise their options or they risk losing the options altogether. Depending on your employer, you may have only 90 days after leaving the company to exercise your stock options, even if you met the vesting schedule requirements.

NSOs and Taxes: A Brief Overview

Compared to incentive stock options (ISOs), NSOs are relatively simple and straightforward concerning taxes. There is a general expectation that a company’s stock will increase over time, which means buying stock on the grant date gives you a “discount” if the grant price (FMV) is lower than what investors are paying. When the stock option is exercised, you’ll pay income tax on the difference between the grant price (FMV) and current FMV at the time you exercise your options.

To be clear, you do not pay any taxes on your stocks when you’re granted your options. Grants by themselves are not taxable. It’s only when you exercise your options or later sell the stock that you’re liable for taxes on your capital gains.

Typically, taxable NSOs fall into one of four categories:

The difference between the grant price and price at the time you exercise your options is considered taxable income and will usually be included by your employer on your W2. Depending on how long you hold onto the stock, you may be subjected to your regular income tax rate OR the capital gains tax rate (which is usually lower than your income tax rate).

Where to Find Tax Help

At YearEnd, we work specifically with startup employees to help them navigate stock options and tax implications. Contact us today to learn how we can help.

This article is provided for illustrative purposes only; it does not provide personalized tax, legal, financial, or other professional advice. Your situation may be different; consult a professional for information concerning your individual tax, financial, or legal situation before taking any action.