Non-Qualified Stock Options (NSOs)
Definition
Stock options that do not qualify for the special tax treatment of ISOs. NSOs can be granted to employees, contractors, advisors, and board members. The spread at exercise (difference between FMV and strike price) is taxed as ordinary income, and your company withholds taxes at exercise.
Real-World Example
You exercise 5,000 NSOs at a $2 strike price when FMV is $10. The $40,000 spread is treated as ordinary income — your company withholds income tax, Social Security, and Medicare on that amount. Any further gain after exercise is capital gains.
Common Mistake
Assuming NSOs are always worse than ISOs. For employees at companies where the strike price and FMV are very close (common at early-stage startups), the tax difference may be minimal. NSOs also avoid the AMT trap that catches many ISO holders.
Why It Matters
Most stock options granted to non-employees are NSOs, and even employees often receive NSOs for grants exceeding the $100,000 ISO limit. Understanding the tax treatment prevents cash flow surprises at exercise time.
Related Terms
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