The simple rule
When you exercise a non-qualified stock option (NSO), the spread is ordinary income:
Spread = (market value at exercise − strike price) × shares
For employees it's treated as wages: added to your W-2, with federal withholding (usually 22%), Social Security, Medicare and state tax. Growth after exercise is a capital gain when you sell.
An example
You exercise 5,000 NSOs with a $3 strike when the stock is $15.
- Cash to exercise: $15,000
- Ordinary income: $60,000 (with withholding)
- Your basis: $15 per share
- Sell 14 months later at $25: $50,000 long-term gain
Exercising at a private company
At a private company, the market value is the latest 409A valuation. You have to pay both the strike price and the withholding in cash, since you can't sell shares to cover it. That's why many people wait for an IPO or tender offer.
Exercise-and-sell
After the IPO, the most common move is a cashless exercise: exercise and sell the same day. The whole spread is ordinary income, there's no extra capital gain, and the sale pays the strike and withholding.
NSOs vs ISOs
- NSOs are taxed at exercise. ISOs usually aren't, for regular tax.
- NSOs never trigger AMT.
- NSOs get withholding. ISO disqualifying sales don't.
- ISOs can become all long-term gain. NSO spread is always ordinary income.
Watch the withholding gap
Like RSUs, NSO income is supplemental wages withheld at 22%. High earners often owe more. See The RSU withholding gap; the same math applies.
Run it
Add an NSO grant in the calculator to see tax at exercise and after sale.
General information, not tax advice.
Frequently asked questions
How are NSOs taxed when I exercise my options?
When you exercise non-qualified stock options, the difference between the market value at exercise and your strike price is considered ordinary income. This amount is reported as wages on your W-2 and is subject to federal withholding, Social Security, Medicare, and state taxes.
What is the tax treatment if I exercise and sell NSOs on the same day?
If you perform a cashless exercise, the entire spread is taxed as ordinary income. Because you sell the shares immediately, there is no additional capital gain. The proceeds from the sale are used to cover your strike price and the required tax withholding.
How are NSOs different from ISOs regarding taxes?
NSOs are always taxed as ordinary income at the time of exercise, whereas ISOs are typically not taxed for regular income tax purposes upon exercise. Additionally, NSOs involve tax withholding and never trigger the alternative minimum tax, unlike ISOs which can eventually result in entirely long-term capital gains.
Do I have to pay taxes on NSOs at a private company if I cannot sell the shares?
Yes, you must pay both the strike price and the required tax withholding in cash at the time of exercise. Because you cannot sell private company shares to cover these costs, you are responsible for paying these amounts out of pocket using the latest 409A valuation to determine market value.
Official sources (for the detail-minded)
- IRC Section 83The NSO spread is income when you exercise
- Treas. Reg. Section 1.83-7How non-qualified stock options are taxed
- IRC Section 3402Employer withholding on wages, including the NSO spread
- IRS Publication 525IRS guide to non-statutory stock options
Run your own numbers
See your tax, take-home, and what to set aside. Free, and nothing is stored.
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Estimates only. Not tax, legal, or investment advice. See our methodology