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ISOs and NSOs: What is the difference? And what should you know?
These are both types of stock options. Based on specific criteria set by the IRS, stock options can be classified as either qualified (Incentive Stock Options, or ISOs) or non-qualified (Non-Qualified Stock Options, or NSOs).
Before we go on, let’s level-set: A stock option is granted when a company gives you the right, but not the obligation, to buy their stock at a predetermined price. This purchase price remains the same, even if the value of the stock increases. That’s where the upside comes in!
So what’s the difference between ISOs and NSOs? Here’s a quick rundown:
Incentive Stock Options (ISOs):
- Only employees of the company can receive ISOs, and there is a formal plan in place approved by shareholders.
- Taxes! No income tax is due when ISOs are granted or exercised, but the difference between the exercise price and the fair market value (FMV) at exercise (the "bargain element") can trigger the Alternative Minimum Tax (AMT).
- If shares are held for at least one year after exercise and two years after the option grant, any gains between the strike price and FMV are taxed as long-term capital gains.
- ISOs are subject to a $100,000 per year limit on the value of shares that first become exercisable in any one year. Any amount above $100k automatically converts to NSOs. This is referred to as an ISO/NSO split.
- They cannot be transferred, except in the case of death.
Non-Qualified Stock Options (NSOs):
- NSOs can be granted to employees, directors, contractors, and others, making them more flexible than ISOs.
- When NSOs are exercised, the "bargain element" is taxed as ordinary income and subject to payroll taxes, and the company must withhold income and employment taxes at the time of exercise.
- Any gain or loss after exercise is treated as a capital gain or loss when the shares are sold.
- NSOs are not subject to the same $100,000 per year limit as ISOs.
- They can often be transferred, depending on the company's plan.
How and when you exercise (buy) your options and sell your stock can have large implications for your taxes, so if you’re dealing with either type of options and have questions, reach out to Range and our qualified equity experts can help.
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