Equity 101


What is an NSO?

Tue May 17 2022

5 min read

what is an NSO

Key takeaways

  • Non-qualified stock options (NSOs) are a form of equity compensation typically given to non-employees — but can be given to employees under some circumstances.

  • NSOs cost money to exercise but their tax treatment is less favorable than incentive stock options (ISOs).

What is an NSO?

Non-qualified stock options (NSOs)  are a kind of stock option typically given to non-employees (like consultants or other service providers), however, employees may also receive these under other circumstances. An NSO is an option to buy a share at a fixed strike price.

While NSOs work in a similar way as ISOs — as in you’ll have to vest and pay money to exercise them — they do not carry the same tax advantages. If ISOs are the Teslas of the stock option universe, consider NSOs to be the Prius — still an electric ride, but not quite as luxurious (tax-wise).

Also, remember that most NSO grants are subject to vesting. Until equity — in whatever form it has been granted — has vested, the company can take it back, so it's not really yours yet. "Vesting" means the release of the company's take-back right, and the "vesting schedule" is the schedule according to which that release happens. And most importantly, when your ownership begins!

Remember we said NSOs are the less tax-efficient cousin of ISOs? Here’s why:

Taxes and your NSOs

Upon exercising your NSOs, you will immediately owe tax — regardless of whether you sell the shares later. 

Several important things to know about such taxes:

  • These taxes are charged at ordinary income rates rather than under the AMT system like ISOs.

  • This taxable amount is calculated on the difference between your strike price and the fair market value (FMV) at the time of exercise. (Ex. Your strike is $2.00 and the FMV is $6.00 — you’d pay income tax on the $4.00 of gain per share.)

Then, selling the shares is another taxable event. If and when you sell your shares down the road, the timing of when you exercised those NSOs and when you sell them as shares (either on a public or secondary market) will determine whether you pay short-term or long-term capital gains.

The ideal is to only sell when you have qualified for long-term capital gain treatment. To qualify for long-term capital gains, the date you sold those shares must be: 

  • More than one year from the date you exercised your NSOs

Exercising your NSOs

  • Typically most companies only offer 90 days to exercise your vested NSOs from the last day at the company.

  • Make sure to consider the amount of tax you will owe upon exercise on top of the exercise cost itself when saving up to exercise your NSOs or make a plan to use option funding.

  • A basic formula you can use to calculate your potential earnings from an NSO grant is Your net gain = Total sale proceeds - (Your exercise cost + Ordinary Income Tax + Capital Gains taxes).

This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for investment, tax, legal, accounting, or other professional advice. Vested does not provide investment, tax, legal, accounting, or other professional advice. You should consult your own investment, tax, legal, accounting, or other professional advisors before engaging in any transaction or equity decision.

Related Stories

The equity tools on this website are for illustrative purposes only and are not necessarily indicative of future results. No representation is made that results that are similar to those shown can be achieved. Any screenshots or images of these tools contain hypothetical outputs and do not reflect any specific circumstances or anticipated results. See additional disclosures below for more information.

Check the background of Vested Securities, LLC on FINRA's BrokerCheck and see the firm's Customer Relationship Summary here.

By using this website, you understand the information being presented is provided for informational and educational purposes only and agree to our Terms of Use and Privacy Policy. Vested, Inc. (together with its affiliates, “Vested”) relies on information from various sources believed to be reliable, including users and third parties, but cannot guarantee the accuracy and completeness of that information.

Vested, Inc. is a technology company as well as an adviser regulated by the U.S. Securities and Exchange Commission as an exempt reporting adviser. Vested, Inc. also provides free tools to help startup employees understand and make the most of their equity compensation. This includes the Equity Dashboard, Outcome Simulator, Fairness Calculator and AMT Calculator. All company data, including but not limited to valuation, projections and common share price, are estimates derived using public data sets, without any endorsement or influence from the company, and should be used only for informational and educational purposes. These data should not be used as investment advice. The Equity Dashboard allows you to enter your option grant and monitor your equity. The Outcome Simulator allows you to create hypothetical exit scenarios with your own inputs such as exit date and valuation. The Fairness Calculator helps you to see how your option grant compares to those received by other startup employees with similar roles at similar companies. The AMT Calculator helps you understand the possible impact of exercising options on possible Alternative Minimum Tax scenarios. All these tools are for illustrative purposes only and do not constitute tax, investment, financial or any other actionable advice.

While Vested, Inc. is not a broker-dealer, its affiliated subsidiary, Vested Securities, LLC (“VSL”), is a registered broker-dealer and member FINRA/SIPC. Prepaid Forward Contracts (“PFCs”), when brokered, are done so by VSL between share- or option-holders and funds. VSL does not have a direct relationship with investors in the funds.

Nothing on this website should be construed as an offer, solicitation of an offer, or recommendation to buy, sell or hold any security. All investments involve risk, and the past performance of a security or financial product does not guarantee future results or returns. PFCs are highly speculative and are less liquid than publicly traded securities. You should consider these risks and your investment objectives carefully before investing or participating in any securities transaction. Vested does not provide legal, tax or financial planning advice.

Company logos are provided by Clearbit. All company names, logos and brands that appear on this website are property of their respective owners. All company, product and service names and logos used in this website are for identification and informational purposes only. Use of these names, logos and brands does not imply endorsement.
Form CRS Reg BI FAQs - CIP Public Notice -BCP Public Disclosure Statement