Non-Qualified Stock Options (NSOs)
Options taxed as ordinary income on the spread at exercise — no AMT preference like ISOs, but no preferential rate either.
When you exercise an NSO, the difference between the strike price and the market value is ordinary income, reported on your W-2 if you're an employee. There's no AMT preference like ISOs, but no preferential rate either. NSOs from a former employer often sit forgotten at an old custodian — exactly the kind of stray account a household-wide view is built to surface.
Ordinary income at exercise
When you exercise a non-qualified stock option, the spread between your strike price and the stock's market value is taxed as ordinary income — and if you're an employee, it's reported on your W-2 with taxes withheld. From there, the shares carry a basis equal to that market value, so any further gain or loss when you sell is a capital gain or loss.
No AMT, but no preferential rate either
Unlike ISOs, NSOs create no AMT preference item — the tax is simpler and ordinary. But that simplicity cuts both ways: there's no path to long-term capital-gains treatment on the spread the way there is with a qualifying ISO disposition. NSOs from a former employer also have a habit of sitting forgotten at an old custodian, with an expiration date quietly approaching.
How Formation handles it
Formation tracks option grants — strike, vesting, and expiration — across current and former employers, so an NSO grant about to expire or a concentrated position isn't lost in an account you no longer log into. The exercise decision and its timing stay yours to make with your advisor.
A worked example
You exercise 5,000 NSOs with a $4 strike when the stock is worth $20. The $16 spread on 5,000 shares — $80,000 — is ordinary income on your W-2 this year. Your basis becomes $20/share, so if you later sell at $26, the extra $6 is a separate capital gain.
Frequently asked
How are NSOs taxed?
The spread between strike and market value at exercise is ordinary income (on your W-2 if you're an employee). After exercise, additional gain or loss when you sell the shares is a capital gain or loss based on the exercise-date value.
What's the difference between NSOs and ISOs?
NSOs are taxed as ordinary income on the spread at exercise, with no AMT and no special holding-period benefit. ISOs can qualify for long-term capital-gains treatment if you meet holding periods, but the spread is an AMT preference item.
In Formation
Equity comp across employers
See this in your own numbers.
Formation organizes your whole household by entity and cites every figure to its source — the context that makes terms like this actionable.
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