Non-qualified Stock Options
Have you ever wondered what NQSOs are and why they are used by corporations? I mean, why would an employer intentionally choose an employee stock option that has no tax incentive both for the employee and the corporation? To better understand the world of NQSOs let me explain how they work.
NQSO of Non-qualified stock option is a kind of employee stock option offered by the companies to their employees, or non-employees, as compensation for their services. Like other employee stock options, NQSO gives the employee the choice of buying the company’s stocks for an option price within a period before expiration. NQSO are different from other employee stock options as it does not offer any tax benefits to the employee and the employer. This means that the employees are still going to be taxed by exercising stock options.
NQSO are taxed from the moment the corporation grants the option to the employee, assuming that the stock option has a determined value. However, since most NQSO have no ascertainable amount at the time of grant it is taxed at the time of exercise by the employee. Now, other than the obvious benefits of employee stock options in general, why would employers choose NQSOs over say ISOs (Incentive Stock Options) and ESPPs (Employee Stock Purchase Plans)? Well, for one, the NQSOs are not as restricted and limited as the other kinds of employee stock options. Employers have more freedom in choosing the provisions, durations and strike prices of their employee stock options. Employers can choose to give out NQSOs to non-employees that have been a valuable part of the corporation such as consultants or individual contractors.
Also, since NQSOs are not limited to restrictions saying that the option price must at least be equal to the share price or not less than 85% of the share price, employers can set even lower option prices that would greatly benefit the employee.
Furthermore, unlike ESPPs and ISOs that have shelf lives of at most only 5 years or 10 years, respectively, NQSOs can have a longer option life than other employee stock options. This would give the employee more opportunity to profit.
Because it has no restrictions, NQSOs can give the employees the power to own more than $100,000 or $25,000 worth of shares of stock per year. Employees can also own more than 12% or 10% of the corporation’s voting power in NQSOs as opposed to other kinds of employee stock options. And lastly, unlike ISOs and ESPPs, NQSOs can have provisions saying that the stock can be transferred to and exercised by someone other than the employee.
Although many may think that Non-qualified stock options are not beneficial to employees at all because of the lack of favorable tax treatment, NQSOs can actually turn out to be better than other employee stock options in terms of benefits and possible profit. Also, unlike in ISO and ESPP where the employee still has to wait until the holding period is over to be able to sell the stocks they obtained from the stock option, possibly losing money over it, stocks obtained from NQSOs can be sold immediately. So when you really think about it, NQSOs give you more flexibility, more profit and more opportunities to profit. I hope this discussion shed some light into your NQSO queries and helped you understand the topic of NQSO.