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.
By Michael Andrews May 3, 2017 - 5:00 pm
What is the long-term-capital-gains holding period for a nonstatutory stock option? Where is that to be found in the Internal Revenue Code?
By James May 11, 2017 - 9:22 pm
I could be wrong, but I don’t think there’s a ‘holding period’ for a non-statutory stock option. The point of a statutory stock option is to tax the realized gain at the lower, more favorable capital gains tax rate rather than at the higher ‘ordinary income’ rate. A non-statutory stock option doesn’t share this preferential tax treatment and any realized gain is considered ‘ordinary income.’ Therefore, there’s no point in having a ‘holding period’ with a non-statutory stock option because there is no preferential tax treatment.
By Joe Wallin May 12, 2017 - 8:41 am
That is correct James. Once you exercise your NSO, you then start your capital gains holding period.
By James May 12, 2017 - 6:02 pm
Joe,
So after you exercise your stock option and buy the stock, then you begin your holding period for capital gains. I’m studying taxes on my own with the help of an EA review book. I don’t have any formal instructor to ask questions of, but to make sure I am right on this, you mean that once you exercise the option and buy the stock at the strike price, your holding period for capital gains (long-term vs short-term) starts. So, if you hold your stock for at least 1 year and 1 day starting the day after you exercised your option, then you dispose of it, you can still qualify to pay the capital gains rate rather than ordinary income rate because of the fact it was a long-term capital gain. Right?
By Joe Wallin May 13, 2017 - 10:06 am
Yes.
By Binary Today Trader August 18, 2017 - 5:01 pm
Your look at binary options trading differs from almost
all of the blog posts I go through, I’m pleased.
By Joe September 21, 2017 - 12:34 pm
It seems there is no immediate benefit to buying/holding the nonstatutory options vs a cashless exercise, since the bargain element is treated as compensation regardless. Your basis is essentially increased to the current FMV when you exercise, so only the future increase in the stock is considered for possible long-term tax rates if you decided to hold them.