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Taxation. The main difference between ISOs and NQOs is the way that they are taxed. NSOs are generally taxed as a part of regular compensation under the ordinary federal income tax rate. Qualifying dispositions of ISOs are taxed as capital gains at a generally lower rate.
A short recap of how your ISOs are taxed: You pay AMT when you exercise them (unless the AMT you owe is lower than your AMT threshold) You again pay tax when you sell them (or, to be precise, when you sell the shares you bought by exercising them) and make a gain.
The main difference between ISOs and NSOs is that ISOs come with no tax liability on exercise, but come with a set of requirements, whereas NSOs come with tax liability on exercise, but do not have the same requirements.
Taxation on nonqualified stock options As mentioned above, NSOs are generally subject to higher taxes than ISOs because they are taxed on two separate occasions ? upon option exercise and when company shares are sold ? and also because income tax rates are generally higher than long-term capital gains tax rates.
NQOs are unrestricted. As such, they can be offered to anyone. That means that you can extend them to not just standard employees, but also directors, contractors, vendors, and even other third parties. ISOs, on the other hand, can only be issued to standard employees.
How are NSOs taxed when exercised? In short: You pay ordinary income tax rates on the difference between the strike price and the 409A valuation. Your employer already withholds a part, but it's the bare minimum (usually 25%)
ISOs have more favorable tax treatment than non-qualified stock options (NSOs) in part because they require the holder to hold the stock for a longer time period. This is true of regular stock shares as well.
You report the taxable income only when you sell the stock. And, depending on how long you own the stock, that income could be taxed at capital gain rates ranging from 0% to 23.8% (for sales in 2023)?typically a lot lower than your regular income tax rate.