ISO vs NSO - What's the Difference?

The main differences between ISOs and NSOs all have to do with taxes.

1. Definition

More formally known as Qualified Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs or NQSOs). The qualification refers to eligibility for special tax treatment.

2. AMT or Ordinary Income Tax

When you exercise either stock option, there is a spread between the exercise price and the current Fair Market Value (FMV) that is subject to Tax and are exempted from ordinary income tax on the spread. However, exercising an ISO is subject to Alternative Minimum Tax (AMT), which comes into play for wealthier tax payers or when the spread is large. NSOs are subject to the higher ordinary income tax rate on the spread as well as the payroll taxes (Medicare , FICA, etc.) for both the employee and employer. Employers also have to pay Federal Unemployment Tax Act (FUTA) early in the tax year. Individuals who are in an ordinary income tax bracket lower than the AMT rate are inherently not subject to AMT while others below a high income phase out (As of 2019: $510,300 single, $1,020,600 married) benefit from an annual exemption (As of 2019: $71,700 single, $111,700 married) which allows a significant number of ISOs to be exercised before triggering AMT.

3. Expiration

ISOs only apply while you are still employed at the company that issued the grant and cannot be extended beyond 90 days after you leave. NSOs don’t require employment and can be extended well beyond 90 days. Moreover, both types of grants can only last 10 years before they must be exercised regardless of whether the holder is still employed at the company. An NSO grant can be crafted to last longer than 10 years and even have an exercise price lower than the current FMV but it will be subject to immediate taxation at the ordinary income tax rates so this is rare.

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