Technology Startup Inc. (TSI) grants a nonqualified stock option to Edward, one of its vice presidents, to purchase 1,000 shares after five years of employment. The option has an exercise price of $10 per share and the current fair market value is $30 per share. Edward exercises today. His marginal tax rate is 24%. What is the tax due upon exercise?

Technology Startup Inc. (TSI) grants a nonqualified stock option to Edward, one of its vice presidents, to purchase 1,000 shares after five years of employment. The option has an exercise price of $10 per share and the current fair market value is $30 per share. Edward exercises today. His marginal tax rate is 24%. What is the tax due upon exercise?

• A. $10,000.
• B. $7,500.
• C. $4,800.
• D. $0, because he hasn't sold the stock yet.

Answer: (C)

Nonqualified stock options are taxed at exercise on the spread between the market value when exercised and the strike price as ordinary income. Here, the spread is $30 − $10 = $20 per share. For 1,000 shares, that’s $20,000 of ordinary income recognized at exercise. With a 24% marginal tax rate, the tax due is 0.24 × $20,000 = $4,800. The tax is incurred now, regardless of any future sale, which would generate additional capital gain or loss based on the sale price minus the exercise price.

Nonqualified stock options are taxed at exercise on the spread between the market value when exercised and the strike price as ordinary income. Here, the spread is $30 − $10 = $20 per share. For 1,000 shares, that’s $20,000 of ordinary income recognized at exercise. With a 24% marginal tax rate, the tax due is 0.24 × $20,000 = $4,800. The tax is incurred now, regardless of any future sale, which would generate additional capital gain or loss based on the sale price minus the exercise price.