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Non-Qualified Stock Option Exercise or NQO
Two Primary Methods
This will provide a basis for understanding the two primary methods of exercising non-qualified stock options - purchase for cash and using previously acquired stock in exchange for cash.
Exercise of an NQO is a taxable event. The bargain element (the difference between the value at exercise and option price) is treated as compensation, included on the W-2 Form at year-end. Income tax withholding is required. Federal withholding will be at 20% of the taxable income. State and local tax withholding is at the appropriate rate. Because this is non-cash income, you will be required to pay tax withholding at the time of the exercise for inclusion as tax withholding on the W-2 Form.
If the stock is sold, any gain is taxed as ordinary income. Gain is the difference between the price when the stock is sold and the price at the date of exercise (cost basis). In the example, the cost basis is $40 and the sale price is $50 per share.
| Non-Qualified Stock Option Exercise | ||
|---|---|---|
| Assumptions | Cash Exercise | Stock/Stock Exercise |
| Number of Options Exercised | 100 shares | 100 shares |
| Option Price | $30/share | $30/share |
| Cost of Exercise ($30x100 shares) | $3,000 | $3,000 |
| Market Price on Exercise Date | $40/share | $40/share |
| Bargain Element | $1,000 | $1,000 |
| Number of shares required for stock-for-stock exercise | N/A | 75 shares |
| Number of new shares acquired in stock-for-stock exercise | 100 shares | 25 shares |
| Sales Price (Acquired Stock is sold more than six months after option is exercised) | $50/share | $50/share |
| Total Sales Proceeds | $5,000 | $1,250 |
| CALCULATIONS | Cash Exercise | Stock/Stock Exercise |
| Value of Stock at Exercise | $4,000 | $4,000 |
| Cost of Exercise | (3,000) | (3,000) |
| Taxable Income at Exercise | $1,000 | $1,000 |
| Maximum Federal Tax Rate | 39.6% | 39.6% |
| Ordinary Income Tax | $396 | $396 |
| Sales Proceeds | $5,000 | $1,250 |
| Adjusted Cost Basis ($40/share) | (4,000) | (1,000) |
| Taxable Gain | $1,000 | $250 |
| Ordinary Income Tax at 39.6% | $396 | $99 |
| Sales Proceeds | $5,000 | $1,250 |
| Cost of Exercise | (3,000) | ( 0) |
| Total Taxes Paid | ( 792) | ( 495) |
| Net Gain After Tax | $1,208 | $ 755 |
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