Nonqualified stock options (NQSOs) are also known as nonstatutory stock options. You report NQSO income differently than you report income from these:
Incentive stock options
Options granted under an employee stock purchase plan
When you receive NQSOs, you usually don't recognize income until you exercise the options. You don't have total control over the stock. If you don’t exercise your options within the required time period, you’ll lose them.
To learn more, see Publication 525: Taxable and Nontaxable Income at www.irs.gov.
However, the option might have a readily determinable market value. If so, you’ll have to recognize income when you receive the option. Options traded in an open market have readily determinable market values. (Ex: New York Stock Exchange)
When you exercise your options, you'll have W-2 income equal to the difference between:
The option price
The stock’s fair market value on the date you exercised your options
Your employer will include that amount on your W-2, box 1. The code “V” will be in box 12.
The difference between the option price and the fair market value when you exercised your option is included in your W-2 income. So, you'll have already paid taxes on it. The basis of the stock is the fair market value of the stock on the date you exercised the options.
You’ll use this equation:
Amount you paid + amount included in your income = fair market value
You can often do a paperless transaction in which you exercise your NQSOs and sell the stock at the same time. Even though you perform only one transaction, it’s really two transactions: You exercised your options, and you sold the stock.