Nonqualified Option (NQO)
What it is:
A nonqualified option (NQO) is the right but not theto purchase of a company, usually the holder's employer, for a fixed price by a certain date.
How it works/Example:
Let's say you work for Company XYZ, and the company grants you options to buy 1,000 shares rise to $60 and you have the right to buy shares for $40, you could exercise your options, pay $40,000 for your shares ($40 x 1,000), and turn right around and sell them in the for $60,000. You'd make $20,000 of easy money. However, that the are only valuable if the stock is trading above $40 per share before the options expire. Usually, companies options with strike prices above the current market price.for $40 a share in the next 10 years. If Company XYZ
Why it matters:
There are two primary kinds of employee stock options (ISOs).
Holders of NQOs pay ordinary income tax on the difference between the exercise price and the of the when they exercise. So, let's say that three years after your 1,000-option , Company XYZ stock is up to $60. You decide to exercise even though only 600 of your options are vested. You think the stock is going to continue to increase, so you hold onto the .
Even though you haven't sold the shares, you have to pay ordinary income tax on the difference between the exercise price and the market value at the time of exercise. In our example, that difference would be 600 shares x ($60 - $40) = $12,000. If you're in the 28% tax bracket, that means you'll pay $3,360 even though you haven't sold the shares yet. And watch out -- you'll pay capital gains tax if you eventually sell the shares for more than $60.