Non-Qualified Stock Option (NSO)

What it means

A Non-Qualified Stock Option (NSO) gives you the right to buy company stock at a set price. Think of it like a coupon that lets you purchase shares for less than what they are actually worth on the open market.

When you decide to use this coupon to buy shares—a process called exercising—the difference between the price you pay and the current market value is treated like a regular paycheck. Because of this, the government requires the company to take out taxes immediately, just like they do with your normal salary.

A simple example

Imagine Sarah is granted an option to buy 100 shares for $5 each. This is her strike price. Later, the shares are worth $15 each, which is the fair market value. When Sarah exercises, she pays $500 to buy the shares. Because the shares are actually worth $1,500, she makes a $1,000 profit. This $1,000 profit is the spread. Sarah must pay income tax and FICA taxes on that $1,000, and her company will usually handle the withholding for her.

Why it matters to you

• Your tax bill happens as soon as you buy the shares, even if you do not sell them yet.
• You do not have to worry about the Alternative Minimum Tax (AMT), a separate tax system that can catch people with other types of stock options.
• Any profit you make after you buy the shares will be taxed as a capital gain, which is a different tax rate applied when you sell the stock later.

Common mistakes to avoid

• Forgetting that you need cash on hand to pay for the shares plus the taxes due at the time of exercise.
• Not checking your paystub to ensure the correct amount was withheld for taxes.

Words used on this page

• Strike Price: The price you pay to buy your shares according to your option agreement.
• Fair Market Value (FMV): The actual price a share is worth on the open market today.
• Exercise: The act of using your option to buy the company stock.
• Spread: The profit you make when you buy shares for less than their current value.
• Withholding: The taxes your employer takes out of your paycheck or stock gain to pay the government.
• Capital Gain: The profit made when you eventually sell your shares for more than what you paid for them.