Non-Qualified Stock Option (NSO)
Also: NSO, NQSO, non-qualified stock option, nonstatutory stock option
A stock option that does not meet ISO requirements. The spread between FMV and strike is taxed as ordinary wage income at exercise, with payroll tax and supplemental withholding.
An NSO is any employee or contractor stock option that is not an ISO. At exercise, the spread between the strike price and fair market value is ordinary wage income, reported on the W-2 for employees or on Form 1099-NEC for contractors. Payroll taxes apply, and employers withhold federal income tax at the 22% supplemental rate up to $1 million of supplemental wages in a calendar year, then 37% above that threshold.
Example: 20,000 NSOs at a $3 strike exercised when the 409A FMV is $18. The $300,000 spread lands on the W-2, and the employer withholds $66,000 federal plus Social Security and Medicare. After exercise, the shares have a cost basis equal to FMV at exercise, $18.
Common mistake: forgetting that a state and NIIT shortfall accrues even when the company withholds federal supplemental tax. A California resident exercising NSOs owes an extra 10.3% or 13.3% at the state level.
NSOs matter when timing an exercise against a liquidity window, coordinating cash from a same-day sale, and sequencing against ISO exercises in the same year to manage AMT.