Understanding Non-Qualified Stock Option: Key Legal Insights
Definition & Meaning
A non-qualified stock option (NSO) is a type of stock option that does not meet the criteria established for incentive stock options under U.S. tax law. When an individual exercises a non-qualified stock option, the difference between the exercise price and the market value of the stock on the exercise date is considered taxable income. This amount is taxed as ordinary income, which means it is subject to income tax and payroll taxes.
Legal Use & context
Non-qualified stock options are commonly used in the context of employment compensation. They are often offered by employers as a way to incentivize employees and align their interests with those of the company. Since NSOs do not meet the requirements for incentive stock options, they are subject to different tax treatments. Employers can also benefit from tax deductions equal to the amount included in the employee's income when the options are exercised.
Real-world examples
Here are a couple of examples of abatement:
Example 1: An employee is granted a non-qualified stock option with an exercise price of $10 per share. When the employee exercises the option, the market value of the stock is $15 per share. The taxable income for the employee would be $5 per share, which is the difference between the exercise price and the market value.
Example 2: A company offers non-qualified stock options to its executives as part of their compensation package. When these options are exercised, the company can deduct the amount that the executives must report as income, benefiting both the company and the employees financially.