An employee receiving a nonqualified
stock option may be taxed, in most cases, at any of the following times:
(1) when the option is received;
(2) when they exercise the option; or
(3) when restrictions (if any) on disposition of the stock (acquired by the option)
Timing of Tax
Employees or independent contractors receiving nonqualified stock
options are taxed upon receipt if the option has a readily ascertainable fair market value
(FMV). This rule usually applies to publicly traded stock. In almost all other situations,
however, the employee is taxed when the nonqualified option is exercised. In either case,
the income is the FMV of the stock minus the strike price (the price paid per share to
exercise an option). In contrast, employees who receive a statutory stock option are not
taxed until they sell the stock.
Most companies require that employees work for a requisite period or meet
certain performance goals before they are eligible for nonqualified stock options. Once
those requirements are satisfied, the options become "vested," regardless of
whether or not he or she chooses to exercise any options.
For additional information on Nonqualified Stock Options and
employee stock options in general, please see the Tax Prophet's section Employee Stock Options..
The Tax Prophet