Step-by-step · 3 min read
NSOs: non-qualified stock options
Non-qualified stock options (NSOs, sometimes called NQSOs) are the most common type of option for advisors, contractors and later-stage employees. They are simpler than ISOs: no AMT question, and no holding periods to qualify for special treatment.
The trade-off is that the spread at exercise is taxed as ordinary income right away, with payroll taxes if you are an employee. Planning is mostly about when to exercise, how much and how to pay for it.
- Who it fits
- Employees, advisors and contractors with non-qualified options.
- Usually not a fit
- Holders of ISOs only. See the ISO guide.
- Figures
- 2026 tax year
The key rule
When you exercise, the spread (market value minus strike price) is ordinary income. For employees it appears on your W-2 with withholding. Your cost basis becomes the market value on the exercise date, and any later change is a capital gain or loss.
How it works
At grant and at vest, nothing is taxed. At exercise, you pay the strike price and recognize the spread as income. Employees have federal and state income tax, Social Security and Medicare withheld, usually at the 22% federal supplemental rate. Advisors and contractors receive a Form 1099-NEC instead and may owe self-employment tax.
After exercise, the shares are like any other stock you own. Hold them more than a year for long-term capital gains treatment on any further growth.
6 steps
List your options
For each grant: number of vested options, strike price, current share value and expiration date. Options with a strike above the current value ("underwater") have no exercise value for now.
Pick the exercise method
- Cash exercise: you pay the strike and the tax, and keep all the shares.
- Sell to cover: some shares are sold to pay the strike and tax; you keep the rest.
- Cashless exercise: all shares are sold right away and you receive the net cash.
Spread large exercises over years
Because the spread stacks on top of your salary, exercising part in December and part in January can keep more of it out of the top bracket. We can show you where the bracket edges are.
Check the withholding
Withholding at 22% is often too low. Plan an estimated payment or extra W-4 withholding for the rest.
Decide whether to hold the shares
After a cash exercise, any future growth can become long-term gain after a year. But you are adding to a single-stock position. Hold only what you are comfortable owning.
Keep expiration dates on your calendar
Options typically expire ten years after grant, and usually within 90 days of leaving the company. Put the date on your calendar a year ahead so you are never forced into a rushed exercise.
Example
Splitting an exercise
You hold 10,000 vested NSOs with a $5 strike, and the stock is $35. The spread is $300,000. Exercising half in December and half in January puts $150,000 in each year instead of $300,000 in one, which can save several percentage points of tax on part of it.
Common mistakes
- Exercising private-company NSOs creates a tax bill even though you cannot sell the shares. Make sure you have the cash.
- Contractors often forget self-employment tax on the spread.
- Letting options expire because the deadline passed during a job change.
Key dates
- Exercise date
- Income is recognized and withheld (employees).
- 90 days after leaving (typical)
- Usual deadline to exercise vested options.
- Ten years from grant (typical)
- Final expiration.
Questions we hear
Are NSOs worse than ISOs?
Not necessarily. NSOs avoid AMT complexity and are easier to plan. ISOs can be better if you can hold the shares long enough.
What to send us
- Option grant agreements
- Exercise confirmations
- Your expected income this year
Upload them to your client portal.
General education for TaxSquad clients, not advice for your situation. Rules and figures change. Talk to us before acting on this guide.