Let’s say Jill joins XYZ Company in June 2018 and is given a non-qualifying stock option for 1,000 shares at a grant/exercise/strike price of $5. For simplicity sake, we’ll say that shares will vest at 25% per year:
- June 2018: Stock option granted
- June 2019: 250 shares vested
- June 2020: 250 shares vested
- June 2021: 250 shares vested
- June 2022: 250 shares vested
In June 2022, all 1,000 shares of XYZ Company’s stock have vested. Jill decides to exercise her option to buy all 1,000 shares at her grant price of $5 per share when the value of XYZ Company’s stock is $50 per share.
Jill writes her company a check for $5,000 (1,000 shares x $5 per share), and the company in returns gives Jill 1,000 shares of stock. Jill is now officially a stockholder.
How NSOs are taxed: Jill paid $5 per share for a stock that is valued at $50 per share. This $45 difference is considered income to Jill and is included on her Form W-2:
1,000 shares x $45 difference between grant price ($5) and fair market value ($50) = $45,000 included on Jill’s Form W-2
Sale of NSO Stock: If the stock is held for one year or longer past the exercise date, long-term capital gains tax rates apply. Otherwise any gain is considered ordinary income.