NSOs (Non Qualified Stock Options) can be the path to wealth! Using these options is complicated, but here are some pointers to help you manage them. In this article we will cover how to handle your NSOs and taxes.
NSO Overview
An NSO is non qualified, meaning that it doesn’t get preferential tax treatment like their cousins, ISOs (Incentive Stock Options). However, when comparing the two types of options, there are some advantages to NSOs:
- No $100k rule
- No AMT (Alternative Minimum Tax)
- No holding period requirement
No $100K Rule
ISOs have the $100k rule, which means that at the time of grant, the fair market value of the ISOs that vest cannot exceed $100k in a calendar year. On the other hand, NSOs have no annual dollar limit. An amount of NSOs larger than $100k can make up for the tax disadvantage, and then some!
No AMT
With ISOs, you may have to pay the AMT, which can be a nuisance during tax time. You probably already guessed it, but there is no AMT with nonqualified options – another benefit. Their tax treatment with is very straightforward.
No Holding Period Requirement
When you have ISOs, you must hold them for at least 2 years – one year after the grant date followed by one year after exercise. If you don’t meet this time horizon, your tax incentive disappears and your ISOs become NSOs.
Taxes on NSOs
The moment you exercise your NSOs you must pay tax on the option exercise. They are taxed as compensation so you have to pay ordinary income taxes and FICA taxes.
When you sell the shares that you own via the NSO exercise, you will pay capital gains taxes on the shares. The amount of tax corresponds to how long you own the shares. One year or less is short term capital gains taxes. One year and one day, or longer, is long term capital gains taxes.
On the surface, taxes on NSOs seem to be unjust, but if you manage them well, you can have a lot more wealth.