Q: What is a nonqualified or nonstatutory stock option?

A: A nonqualified or nonstatutory stock option (an “NQO”) is a type of compensatory stock option that is not intended or does not qualify to be an incentive stock option (an “ISO”) under the Internal Revenue Code. ISOs are only available to employees (not non-employee directors or independent contractors), and there are mathematical limitations on the amount of an option that can qualify as an ISO.

The purported advantage of incentive stock options is no “ordinary” income upon exercise of an option in the money. The problem is that this statement, while technically true, is not complete–because the spread on the exercise of an ISO is an alternative minimum tax adjustment. Thus, depending on the particular circumstances of the optionee exercising an ISO, the alternative minimum tax due as a result of the exercise can be quite significant.

Please see the article I wrote on this point.

Q: Is the receipt of a nonqualified stock option taxable?

A: No, there is no tax on the receipt of an NQO as long as the exercise price of the stock option is equal to the fair market value of the stock on the date of grant.

Q: What are the tax consequences of exercising a nonqualified stock option?

A: The spread on exercise–meaning, the amount by which the fair market value of the stock at the time of exercise exceeds the exercise price–is ordinary income, and subject to ordinary income and wage witholding.

Q: When does my capital gains holding period start on stock option shares?

A: Your capital gains holding period does not start until you exercise the stock option.