NSO taxation

Non-qualified stock options (also called NQSOs) are the default flexible option type. Companies can grant them to employees, contractors and advisors. Equity compensation is taxed by events: grant, vest, exercise, sale. For NSOs, the event that usually hurts is exercise.

None of this is legal or tax advice. It is the map so you know when to hire a professional before you click Exercise in Carta.

The big idea

At grant: usually no tax if the option has no readily ascertainable FMV (standard for private startup options).

At exercise: you recognize ordinary compensation income equal to the spread:

spread = (FMV_at_exercise − strike) × shares_exercised

The company often withholds income and employment taxes as if it were a bonus. Private-company FMV is typically the latest 409A common price.

At sale: gain or loss after exercise uses a basis of FMV at exercise (you already paid tax on the spread). Hold more than one year after exercise for long-term capital gains on post-exercise appreciation.

A same-day cashless or sell-to-cover in an acquisition is the simple path: FMV equals deal price, ordinary income on the full spread, leftover capital gain may be tiny. Expensive at ordinary rates, no ISO AMT drama.

Walking through a sale

10,000 NSOs, strike $1.00, 409A FMV at exercise $4.00.

Spread = 10,000 × ($4 − $1) = $30,000 ordinary income at exercise
Basis in shares = $40,000

Sell two years later at $9.00:

Capital gain = 10,000 × ($9 − $4) = $50,000 long-term (federal)

Plus whatever you already paid on the $30k. You also paid 10,000 × $1 = $10,000 of strike cash at exercise.

Common mistakes

• Exercising a large spread with no buyer. Ordinary income is due even if the shares cannot be sold.
• Assuming the sale is all capital gain. The spread at exercise already went through ordinary rates.
• Ignoring withholding. Private companies may not withhold like a public employer; you still owe the tax.

Check yourself

5,000 NSOs, strike $2, FMV $6 at exercise. How much ordinary income?

5,000 × ($6 − $2) = $20,000.

You sell those shares a month later at $6. Additional capital gain?

About zero. Basis is FMV at exercise ($6), and you sold at $6. The $20,000 was already ordinary income.

Key takeaways

• NSOs: ordinary income on the spread at exercise; later appreciation is capital.
• Basis after exercise is FMV at exercise, not the strike.
• Same-day sale at exit is simple and often expensive at ordinary rates.
• No cash from a sale does not mean no tax.

Further learning

Next, the ISO path and its AMT trap: ISOs and AMT.