Differences ISO vs. NSO





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This limit causes larger grants to be split into ISOs and NSOs. Gain or loss when the stock is sold is long-term capital gain or loss. That does not apply to NSO holders and, consequently, a plan that consists solely of outstanding NSOs rather than ISOs is much more easily transformed into a plan with extended PTEP.


Non-Qualified Stock Option (NSO) - A company may generally take a deduction for the compensation deemed paid upon exercise of an NSO. The recipient receives ordinary income or loss upon exercise equal to the difference between the exercise price and the fair market value of the stock at date of exercise.


If you work for a corporation, you may be awarded employee stock options at some point. Employee stock options can be either incentive stock options ISOs or non-qualifying stock options NSOs. ISO stock options provide a tax break that NSOs do not. The rules for each type of stock option are different. ISOs and NSOs NSOs, also called non-statutory stock options, allow you to buy stock in the company at a predetermined exercise price, usually for a period of several years. If the company stock goes up, you can exercise the stock options to buy shares and then sell them at the market price. NSOs can be awarded to non-employees such as consultants or members of the board of directors as well as to employees. ISOs, also called statutory stock options, work the same way, but may only be awarded to employees of the company, a parent company or a subsidiary. The big difference is that ISOs are tax advantaged. If you follow Internal Revenue Service rules, all of your profits are treated as long-term capital gains with a maximum tax rate of 15 percent. NSO profits are considered ordinary income and are taxable at a rate of up to 35 percent. When you exercise NSOs, the difference between the exercise price you pay and the market price of the stock on the date of the exercise is your profit and is referred to as the bargain element. The bargain element is considered compensation and is taxable as ordinary income in the year the options are exercise. Your employer must list the bargain element as income on your W-2 form, which is not required for ISOs. ISO Exercise In order to get the tax advantages of ISOs, you have to wait one year or longer after you are awarded the options before you exercise them. After you buy the stock, you have to hold it for at least one additional year. You normally do not have to pay taxes on the bargain element in the year you exercise ISOs. Provided you meet the holding time requirements, all of your profit qualifies as a long-term capital gain. If you leave your job with the company, you have three months to exercise your ISOs or they revert to NSOs. If you are subject to the alternative minimum tax, you may have to pay ordinary income taxes on the bargain element in the year you exercise ISOs. However, you normally get an AMT tax credit you can use in future years. About the Author Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.

 


Qualifying Dispositions and Capital Gains Tax When shares resulting from an ISO are sold at least 1 year after the exercise and 2 years from the grant date, then the sale qualifies for long term capital gains treatment on the spread between the exercise price and the final sale price. In addition, if the underlying nso vs iso acquired upon exercise of an ISO are held until the later of one year following exercise or two years following the date of grant of the ISO, any gain or loss resulting from the sale or other disposition of the underlying securities would be treated as long-term capital gain or loss to the employee. The terms of the options may require employees to wait a period of time for the options to vest. Any number of NSOs can be granted to anybody employee nso vs iso non-employee. However, exercising an ISO is subject to Alternative Minimum Tax AMTwhich comes into play for wealthier tax payers or when the spread is large. That does not apply to NSO holders and, consequently, a plan that consists solely of outstanding NSOs rather than ISOs is much more easily transformed into a plan with extended PTEP. Additionally, for ISO treatment, an option to a 10% Holder by its cannot be exercisable for more than five as opposed to ISOs for smaller holders, which can be exercisable for up to 10 years. No Alternative Minimum Tax Applicable. A large number of ISOs are ultimately disqualified for this reason.