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.
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