Nonqualified Stock Options 30 If you are not an employee and receive stock options, they are always nonstatutory stock options. Caution Despite an option agreement that says you are granted incentive options, the Internal Revenue Service would treat them as NSOs if they don't meet all the requirements of an ISO. No Limits Nonstatutory stock options do not have a limit on the amount of stock you can receive in a single year. In Lesson 5, "Incentive Stock Options," I noted that you couldn't exercise more than $100,000 in incentive stock options in any one year. No such limit exists for NSOs. Tax Consequences of NSOs Nonqualified stock options or nonstatutory options do not qualify for any special tax treatment. You incur a tax liability at the time of grant if there is a readily available way to establish a value on the options. There are almost no circumstances where this is the case. The most common scenario is that employees exercise the options and immediately sell the stock for a profit. Any income from this transaction is ordinary income to the employee. In Lesson 8, "Exercising Your Options," I discuss various ways to exercise your options. For example, you receive nonstatutory stock options for 100 shares of stock worth $30 per share at the time of grant with an exercise price of $35 per share. After vesting, you want to exercise your options. The current price of the stock is $45 per share. You exercise the options and immediately sell the stock. What is your tax liability? First, we need to compute your profit. The exercise price was $35 per share and you sold the stock for $45 per share. Your profit is $1,000 (not including fees and taxes). Grant Price $35 * Fair Market Price $45 Spread $10 Profit * $1,000 ($10 × 100 shares) Before fees and taxes You owe ordinary income tax on the $1,000. Normally you would not pay the tax until you filed your income tax for that tax year. However, if you make estimated tax payments, consult your tax pro- fessional for advice on how to handle your profit. Tip Careful planning can shift most of your taxes to long-term capital gains. See Lesson 9, "Taxes and Options," for more details. What happens if you decide to hold the stock for a while and then sell it? Using the same scenario as above, suppose you decided that rather than sell the stock immediately, you want to hold it for future growth. You still owe ordinary tax on the $1,000 and you may own capital gains tax on the stock if you hold it for more than one year. For example: Grant Price $35 * Fair Market Price $45 Spread $10 Profit * $1,000 ($10 × 100 shares) Before fees