Tax treatment of nonqualified stock options

With nonqualified stock options (NQSOs), if the stock appreciates beyond your exercise price, you can buy shares at a price below what they’re trading for. This is the same as for the perhaps better-known incentive stock options (ISOs).

The tax treatment of NQSOs, however, differs from that of ISOs: NQSOs create compensation income — taxed at ordinary-income rates — on the “bargain element” (the difference between the stock’s fair market value and the exercise price) when exercised. This is regardless of whether the stock is held or sold immediately. Also, NQSO exercises don’t create an alternative minimum tax (AMT) preference item that can trigger AMT liability.

When you exercise NQSOs, you may need to make estimated tax payments or increase withholding to fully cover the tax. Keep in mind that an exercise could trigger or increase exposure to top tax rates, the additional 0.9% Medicare tax and the 3.8% net investment income tax.

The latest news regarding non-qualified stock options (NQSOs) includes changes in tax laws and regulations, as well as updates on the accounting and financial reporting requirements for NQSOs. For example, the Tax Cuts and Jobs Act (TCJA) introduced new tax provisions that affect the taxation of NQSOs, and the Financial Accounting Standards Board (FASB) has issued guidance on the accounting for NQSOs.

Additionally, there are ongoing debates and discussions around the use of NQSOs in executive compensation and their potential impact on corporate governance and shareholder value.

Have tax questions about NQSOs or other stock-based compensation? Let us know — we’d be happy to answer them.