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Definition of Non-Qualified Stock Options (NSOs)

Non-Qualified Stock Options (or "NSOs") are a type of stock option that startups can grant to service providers as compensatory equity. Unlike incentive stock options, which may only be issued to employees, NSOs can be granted to employees, contractors, and other service providers. Unfortunately, though, NSOs don't have the same theoretical tax advantages that ISOs do.

Below is a table to help illustrates some of the key tax differences between ISOs and NSOs:

Tax at GrantNo tax (if granted at FMV)No tax (if granted at FMV)
Tax at VestingNo tax (if granted at FMV)No tax (if granted at FMV)
Tax at ExerciseNo ordinary income, capital gains, or employment tax. However, the difference between the FMV and exercise price is treated as income for purposes of calculating AMT.The spread between FMV and exercise price is taxed as ordinary income.
Tax at SaleSale price less exercise price taxed as long-term capital gains, so long as held for 1 year past exercise and 2 years past grant date.Sale price less FMV at exercise taxed as long-term capital gains if held for 1 year past exercise.

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