Non-Qualified Stock Option

Posted in Finance, Accounting and Economics Terms, Total Reads: 716

Definition: Non-Qualified Stock Option

Non-Qualified Stock Option are stock options for individuals in an organization in which they have to pay an additional income tax, which is calculated as the market value for that particular date and the exercise price.

NSO are the opposite of Incentive Stock Options or ISO’s. In case of ISO’s, the employees get tax benefit because the option when exercised does not require regular income tax to be paid on the difference. Instead capital gains tax rate is charged which is less than the regular income tax rate. There are certain differences between ISO’s and NSO’s. There are huge regulatory requirements associated with ISO’s while no such requirements are present for NSO’s. Some of the requirements are that option cannot be transferable except at death, a 100000$ limit is set on the total aggregate market value of the stock acquired by the employee in a single calendar year, the options must be exercised within 10 years of the grant etc.

Other differences are ISO’s can be given only to employees while NSO’s can be given to anyone. Also in case of ISO’s, employees have to hold the options for a longer time than NSO’s which puts them under market risk. Also NSO’s are generally preferred by the employers as ISO’s are more difficult to understand as there are lot of complexities associated with disqualifying dispositions. To understand how ISO’s and NSO’s work, let’s take an example that a stock of Company A is trading on Rs 100. If the company provides an incentive to its employees by providing ISO’s at strike price Rs 115 after 10 years. If the stock price is Rs 120 at the end of 10 years then the employee has to pay capital gains tax on the profits which is Rs 5 while in case of NSO’s the employee would have to pay tax on difference between the prices which is Rs 20.

Hence, this concludes the definition of Non-Qualified Stock Option along with its overview.


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