Updated July 16, 2020: 

Non-statutory stock options are a fantastic way to reward your employees. This benefit can have a positive impact on their overall income without the company bearing any additional expense.

Non-Statutory Stock Options

An NSO, or non-statutory stock option is a type of compensatory stock that is not meant to be an ISO, or incentive stock option within the Internal Revenue Code. These are employee stock options that are offered without any restrictions.

Non-statutory stock options are also known as a non-qualified stock options. These are a stock option for employees, but also for vendors, the board of directors, contractors, and anyone else the company issues them to.

They are named as such because the will not qualify within the strict guidelines of ISOs. They are more flexible and do not have as many restrictions when it comes to issuance.

While NSOs are easier to provide, and do not require a lot of legal red tape, they still have to maintain all SEC guidelines. This is why it is crucial to work with a corporate securities attorney before you use them.

How Non-Qualified Stock Options Work

NQOs are among the most common stock options provided as employee benefits. You can buy a stock for a certain price for a specified time period while the market value rises. The goal is to make a profit on the shares once the stock vests.

The profit may be conferred immediately for NSOs. There are no restrictions with regard to waiting periods, and you can sell the shares as soon as the vest for an unlimited amount of profit.

There is not a minimum price for this type of stock. A company may set the exercise price as it sees fit. Also, there is no limit to the amount of money employees can make from exercised NSOs.

NSOs and Tax Considerations

The following are tax considerations for NSOs:

  • NSOs are seen as a form of normal income that is received from a company.
  • The recipient is taxed on the date the stock options are exercised on the difference of the stock’s market value and the grant price.
  • This will appear on a W-2 just like other forms of compensation.
  • NSOs are comparable to a cash bonus or other payment for tax purposes.
  • Once sold, the recipient is taxed in the same way as selling any other stock, short-term or long-term capital gains. This will depend on how long you have held the stock.

Advantages of Non-Statutory Stock Options

There are three significant benefits of NSOs for both employees and companies:

1. It will increase the employee’s income without adding to the expense of the employer. An employee can make more money as the stock price rises. The expense is born not by the employer, but by the open market.

2. It will increase the morale and engagement of employees. Benefits generally boost morale, but NSOs are extra special because they provide employees with the opportunity to make an even higher income while gaining the feeling that their overall actions will have a positive impact on their compensation.

3. It offers flexibility with regard to taxes. Since the timing of NSOs exercising is rather flexible, employees can lessen the impact of taxes by delaying the exercise and sale of options until the time is right to make it financially worth it. From the company’s standpoint, they will also have deductions for the amount of spread that is reported as income by employees.

Disadvantages of NSOs

On the flip side, there are some disadvantages of NSOs for both employees and companies to think about before exercising these options:

1. They provide a bigger tax burden. Since NSOs are treated as regular income, exercising the options is a major tax activity that can place employees into a higher tax bracket.

2. There is some risk. There will never be a guarantee that the stock prices will increase. This means that the options can be potentially useless. This will lower employee productivity and morale, not to mention the impact financially.

3. Issues with exercise. If there is the cash required to exercise the options upfront, it can prevent some employees from being able to afford it. Exercises that require no cash can also be problematic for lower-income employees since they could miss out on significant gains when they have to immediately sell exercised shares.

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