Which statement about nonqualified stock options is true?

Which statement about nonqualified stock options is true?

• A. It is taxed only when the stock is sold.
• B. The bargain element is taxed as ordinary income in the year of exercise.
• C. There is no tax event at exercise.
• D. The alternative minimum tax applies to NSOs.

Answer: (B)

Nonqualified stock options are taxed at exercise based on the bargain element—the difference between the fair market value at exercise and the exercise price. This ordinary income is taxed in the year you exercise and is typically reflected on your W-2 as compensation, with payroll taxes applying as well. Your basis in the stock becomes the fair market value at exercise, so when you later sell, any additional gain or loss is capital gain or loss, depending on how long you hold the shares. The alternative minimum tax does not normally apply to NSOs, unlike ISOs where the bargain element can trigger AMT.

Nonqualified stock options are taxed at exercise based on the bargain element—the difference between the fair market value at exercise and the exercise price. This ordinary income is taxed in the year you exercise and is typically reflected on your W-2 as compensation, with payroll taxes applying as well. Your basis in the stock becomes the fair market value at exercise, so when you later sell, any additional gain or loss is capital gain or loss, depending on how long you hold the shares. The alternative minimum tax does not normally apply to NSOs, unlike ISOs where the bargain element can trigger AMT.