NON-QUALIFIED STOCK OPTIONS
If you have non-qualified stock options, you will also probably have options of other types as well. Non-qualified options have unique features and some additional benefits if exercised in the most effective fashion.
There are no statutory restrictions on the Non-Qualified Stock Options that may be granted to an executive in a particular calendar year.
NQOs, once exercisable, may be exercised in any sequence. Later grants can be exercised even though earlier grants are still outstanding and unexercised.
When a NQO is exercised, the difference between the value of stock at the time of exercise and the option price is considered compensation income on which federal, state, and local tax withholding is required.
When a SAR is exercised, the full value of the SAR is also compensation income on which tax withholding is required. Following the exercise of NQOs and SARS, your tax withholding requirements will be subtracted from the SAR cash payment.
FICA tax will be withheld only if you have not paid tax on the maximum FICA wage base for that year.
The bargain element or spread between the option price and the price at exercise is compensation income and will be reflected in your W-2 Form for the year. Taxes withheld as explained in the third item will be included on your W-2 Form.
The income will be taxable as ordinary income and will not receive special tax treatment. Future appreciation from the date of exercise will be taxable when the stock is sold.
Stock-for-Stock exercises are permitted. Thus, the option exercise may be accomplished without a cash payment for the stock. However, cash will be required to pay the income tax withholding requirement referred to in the third item.
The exercise of NQOs does not give rise to an item of tax preference.
NQOs are exercisable after retirement in accordance with the terms of the option.
The basis for any gain or loss when the option stock acquired (via cash exercise) is sold is the original option price plus compensation income recognized at exercise. (i.e.: your tax basis is equal to the market value of stock on the date the option is exercised.)
NQO stock received in a stock-for-stock exercise has a basis equal to the income recognized at exercise.
MAKING DECISIONS
While financial advisors can help, most executives want to have a clear understanding of the option process and strategy. In coming articles we will provide an example of how non-qualified options may be viewed.