Non-Qualified Stock Option Agreement Explained
A non-qualified stock option (NSO) is a type of equity compensation plan that allows employees to purchase shares of the company at a predetermined price. Unlike incentive stock options (ISOs), non-qualified stock options do not have to meet certain tax requirements and are therefore subject to income tax when exercised. In this article, we’ll discuss what a non-qualified stock option agreement is and how it works.
What Is a Non-Qualified Stock Option Agreement?
A non-qualified stock option agreement is a legal document between the employer and employee that outlines the terms and conditions of the NSO. This agreement provides information such as the number of shares, the exercise price, and the vesting schedule.
The exercise price is the amount an employee must pay to purchase each share of stock. Typically, the exercise price is set at the market value of the stock at the time the NSO is granted. The vesting schedule is the timeline over which the employee can exercise the NSO. Often, the NSO will have a cliff vesting period where the employee must remain with the company for a certain amount of time before any of the options can be exercised.
How Does a Non-Qualified Stock Option Agreement Work?
Non-qualified stock options become exercisable at a specific date or on a certain event, such as the achievement of performance goals. Once the options are exercisable, the employee can choose to purchase the shares at the exercise price. If the stock price has increased since the time the options were granted, the employee can sell the shares at a profit.
When the employee exercises their NSO, they must pay ordinary income tax on the difference between the exercise price and the fair market value of the stock at the time of exercise. The company will withhold taxes on the employee’s behalf. If the employee chooses to hold onto the stock, they will be subject to capital gains taxes when they eventually sell the shares.
Conclusion
Non-qualified stock options can be a valuable form of compensation for employees. The NSO agreement outlines the terms and conditions of the options and is a legally binding document. It is important for both employers and employees to understand the terms of the agreement and the tax implications of exercising NSOs. By following the guidelines outlined in the NSO agreement, employees can take advantage of this form of compensation and potentially profit from the company’s success.