NSO (non-qualified stock option) is a type of employee or contractor equity grant taxed under ordinary income rules at exercise — the most flexible and common option type beyond ISO limits.

How it works

The company grants options with a strike price at fair market value on grant date. After vesting, the holder exercises — pays strike × shares to the company — and receives stock. For NSOs, the spread (FMV minus strike) is generally compensation income subject to income and payroll taxes at exercise, regardless of whether shares are sold.

Companies often use NSOs for advisors, international staff, and employees who exceed ISO $100K annual vesting limits. NSOs can have longer exercise windows after departure if the plan allows, though post-termination exercise periods vary.

409A valuations set strike prices; exercising into illiquid private stock creates tax due without cash unless a secondary or tender occurs.

Why it matters

• Founders: Design equity plans knowing NSO vs ISO mix affects recruiting narratives and admin. Tender offers and liquidity programs help employees pay NSO exercise taxes.
• Operators: Model exercise scenarios before clicking — a high FMV spread can produce a large tax bill on paper gains you cannot sell yet. Some exercise-and-sell or cashless exercise programs mitigate this in late-stage companies.

Common mistake

Treating NSOs like ISOs for tax planning. ISOs may defer taxation until sale if holding periods are met; NSOs generally do not.

Related ideas

See also NSO tax, ISO, equity incentive plan, and 83(b) elections (for restricted stock, not options).