Tax Implications of the Five Types of Equity Compensation, Part 4: Non-qualified Stock Options (NQO’s)
Nonqualified Stock Options
As the series continues, Part 4: Non-qualified Stock Options are explored as we compare similarities, differences, tax implications, and timing for exercising options. See example below:
As mentioned in my previous blog, Non-qualified Stock Options (NQO’s) are similar to Stock Appreciation Rights (SAR’s).
What are the differences? The main difference is that SAR’s provide the holder with the right to receive cash and NQO’s provides the holder the opportunity to by a fixed number of shares at a price determined when the options were granted.
- In summary: A NQO holder does not report income until they exercise the option. At the time of exercise, the option holder must pay the exercise price (grant price) and is taxed (compensation income) on the difference between the exercise price and the current price.
Example:
|
Number of Options Granted |
2,000 |
|
Date of Grant |
10/01/2005 |
|
Exercise Price |
$25.00 per share |
|
Current Price |
$45.00 per share |
- If the option holder exercised all the options they would report compensation income of $40,000 ($45-$25 X 2,000).
- If the holder is an employee of the company, the income from exercising the option will be subject to withholding and social security tax.
Dan’s Moral: Because there is no cost or tax implication to the holder at the time the option is granted, options allow the holder to participate in the appreciation of the stock with no cost.
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