Equity compensation · Section 83
With non-qualified stock options, tax is due on the spread when you exercise.
The spread is the shares’ fair market value when you exercise, minus the exercise price you pay. For vested non-qualified stock options (NSOs or NQSOs), the spread is ordinary income in the year you exercise, even if you keep the shares. Any later rise or fall is a capital gain or loss, long-term after you hold the shares over a year.
Updated · Sources
Employee NSO taxation in 2026
- 37%
- is the top federal income tax rate on the spread, which counts as wages.
- 22%
- is the flat federal rate your employer may withhold, even if your bracket is higher.
- 7.65%
- is Social Security and Medicare on the spread. Social Security stops at $184,500 of wages, and Medicare adds 0.9% on wages above $200,000.
Supplemental wages above $1 million a year are withheld at 37%, whatever your Form W-4 says. Pay from businesses under common control with your employer counts toward that total.
Four facts decide your NSO tax treatment.
The IRS calls non-qualified stock options nonstatutory stock options. Most grants match all four facts below. If yours differs on one, its tax changes in timing or in kind.
An option with no market value at grant
Most NSOs are not taxed when granted, because the option has no readily ascertainable fair market value. An option has one only if it trades on an established market, or meets the four strict conditions in Treasury Regulation 1.83-7. That rare option is taxed at grant instead.
No discount on the exercise price
Your exercise price should be at least the stock’s fair market value on the grant date. A lower price generally makes the option deferred compensation under Section 409A. If the option then fails 409A’s rules, you can owe income tax once it vests, plus a 20% tax and interest. You pay that extra tax, not the company.
Shares that are vested when you exercise
If your shares are vested at exercise, the spread is income that year. If you exercise early into unvested shares, the spread is measured and taxed when they vest. An 83(b) election filed within 30 days of exercise moves the tax back to exercise.
Options received as an employee
For employees, the spread is wages on Form W-2, with income tax, Social Security and Medicare withheld. Directors and contractors owe the same income tax, but normally nothing is withheld. They get Form 1099-NEC instead and pay self-employment tax.
A Section 83(i) election lets some private-company employees delay the income tax on the spread for up to five years. The company’s plan must grant options or RSUs to at least 80% of its US employees. Social Security and Medicare are not delayed.
An NSO tax example: what one exercise costs.
Income tax
$70,000
The whole spread is taxed at 35%, on top of your salary.
Withheld
$44,000
At the flat rate, 22% of the spread is withheld at exercise.
Still to pay
$26,000
This is the income tax that withholding did not cover.
Medicare
$4,700
This is 1.45% plus the 0.9% Additional Medicare Tax, all withheld.
The spread is 10,000 shares times $20, the gap between $25 and $5. These are 2026 federal figures for a single filer with a $300,000 salary and the $16,100 standard deduction. That salary already reaches the 35% bracket. Adding the spread still leaves taxable income under $640,600, where the 37% bracket starts. The salary is past the Social Security wage base, so the spread adds no Social Security tax. Because the salary alone is over $200,000, the 0.9% applies to the whole spread.
For NSOs granted after 2013, the 1099-B basis leaves out the spread.
Your broker’s Form 1099-B usually shows just the exercise price you paid as the basis. Unless you correct it on your return, the spread is taxed a second time as capital gain.
| On the 1099-B | Corrected | |
|---|---|---|
| Sale proceeds | $300,000 | $300,000 |
| Cost basis | $50,000 Exercise price only | $250,000 Plus the spread |
| Capital gain | $250,000 | $50,000 |
| Federal tax on the gain | $47,000 | $9,400 |
| On Form 8949 | No adjustment | Code B in column (f) |
This is the exercise from the example above, with the shares sold at $30 each more than a year later. The long-term gain is taxed at 15% plus the 3.8% net investment income tax. Those are 2026 rates for a single filer with a $300,000 salary, used here for the year of sale. When the 1099-B shows basis reported to the IRS, keep its $50,000 in column (e) and enter −$200,000 in column (g). The gain comes out to the same $50,000.
The NSO mistakes that cost the most.
Counting code V twice
The code V amount in box 12 of your W-2 is already inside your box 1 wages. Adding it to your income again taxes the spread twice. Schedule 1, line 8k, is only for stock option income that is not reported anywhere else on your return.
A falling stock price does not undo the tax
The tax on the spread is fixed at exercise and stays, even if the price drops. The drop becomes a capital loss when you sell. Capital losses first offset your capital gains. Up to $3,000 more a year ($1,500 if married filing separately) can offset other income. Any loss left over carries forward to later years.
A same-day sale is still taxed
Exercising and selling at once, a cashless exercise, does not avoid the income. The spread is still ordinary income on your W-2 or Form 1099-NEC. The sale itself shows only a small short-term gain or loss, usually fees and price moves.
A lockup does not delay the tax
Options you exercise during an IPO lockup are taxed at exercise, even though you cannot sell yet. You may owe the tax before you can sell any shares to pay it. For officers and directors exposed to Section 16(b) suits, tax can wait up to six months.
The spread can raise the 3.8% tax on investments
The spread itself is not subject to the 3.8% net investment income tax. It does raise your modified AGI, which can bring more of your dividends and other gains under that tax. The tax applies above $200,000 of modified AGI for a single filer, or $250,000 on a joint return.
Plan the NSO exercise before the tax is fixed.
Valim’s CPAs help employees and directors with NSO tax planning before an exercise, and file the return after it.
- We model the tax on an exercise before you make it, using your own income and brackets.
- We check your NSO tax withholding against what you will owe. We also plan estimated payments for the gap.
- We time exercises and sales around your brackets and any liquidity event, such as an IPO.
- We weigh an early exercise and an 83(b) election when your plan allows it.
- We report the spread and the sale on your return, with the basis corrected on Form 8949.
- Individual return
- from $195
- Business return
- from $495
We quote a flat fee before work starts. We do not bill hourly.
NSO tax questions.
How do NSOs get taxed?
NSOs get taxed when you exercise them, on the spread between the shares’ fair market value and your exercise price. The spread is ordinary income, and for employees it is W-2 wages with income tax and payroll taxes withheld. Directors and contractors get Form 1099-NEC instead. When you sell, any change in value since exercise is a capital gain or loss. If you exercise before your shares vest, the tax waits for vesting unless you file an 83(b) election within 30 days.
Are NSOs taxed twice?
No, the spread on an NSO is taxed once, as ordinary income in the year you exercise. That income becomes part of your cost basis, so the sale taxes only the change in value after exercise. A double tax happens only through a reporting mistake. For options granted after 2013, your broker’s Form 1099-B leaves the spread out of the basis. Add it back on Form 8949 with code B, or the spread is taxed again as a capital gain.
What is the difference between ISO and NSO taxes?
An NSO’s spread is taxed as ordinary income when you exercise, but an ISO exercise creates no regular income tax. For employees, the NSO spread also carries Social Security and Medicare, while the ISO spread counts only toward the alternative minimum tax (AMT). Under the ISO rules, you must exercise while employed or within three months of leaving. Hold the shares two years from grant and one year from exercise, and your whole gain over the exercise price is long-term. NSOs have no holding rule, can go to directors and contractors, and have no $100,000 limit on options first exercisable each year.
What does code V in box 12 of my W-2 mean?
Code V shows the income from exercising non-qualified stock options during the year, and not from ISOs or a Section 423 ESPP. That income is the spread, or bargain element: the shares’ fair market value at exercise minus the exercise price. It is already in boxes 1 and 5 of your W-2, and in box 3 up to the Social Security wage base. Do not add it to your income again. You need the figure when you sell, because the broker’s 1099-B basis leaves it out for options granted after 2013.
Sources
- 26 U.S.C. § 83, Property transferred in connection with performance of services
- 26 C.F.R. § 1.83-7, Taxation of nonqualified stock options
- 26 C.F.R. § 31.3402(g)-1, Supplemental wage payments
- IRS, Publication 15 (2026), Employer’s Tax Guide
- IRS, General Instructions for Forms W-2 and W-3 (2026)
- IRS, Instructions for Form 8949
- 26 C.F.R. § 1.6045-1, Returns of information of brokers and barter exchanges
- IRS, Rev. Proc. 2002-50 (Internal Revenue Bulletin 2002-29)
- IRS, Rev. Proc. 2025-32 (2026 inflation adjustments)
- IRS, Topic no. 427, Stock options
- 26 U.S.C. § 409A, Deferred compensation under nonqualified plans
- 26 U.S.C. § 1411, Net investment income tax
- 26 U.S.C. § 1211, Limitation on capital losses
- IRS, Instructions for Forms 1099-MISC and 1099-NEC
Reviewed and updated September 2026. General information, not advice for your situation.