Tax Deferrals of Non-Qualified Stock Options

by Carol Deeb

Being offered a job requires you to determine if the salary is sufficient for your needs. Other compensation to consider are the benefits that the company can offer. In addition to health insurance, vacation pay and retirement fund contributions, some companies give employees an option to purchase stock at low, locked-in prices. However, when you exercise these stock options, you may be subject to paying income taxes, unless you qualify to defer the tax to a later date.

Non-Qualified Stock Option

Non-qualified stock options, also referred to as non-statutory stock options, are offered to you by your employer for the purchase of shares in your company. Your company allows you to buy a certain amount of stock for a price that is set when you are offered the opportunity. You have a period of time, such as five years, to exercise this option. If the price of the stock rises, you can buy your shares for your locked-in price, which automatically gives you a profit, and hold or sell them at the time.

Tax Criteria

The tax you pay on your profit depends on a variety of criteria, such as when you were given the option, when you purchased the stock and when you sell it. For example, you are given an five-year option to buy up to 100 stocks for $5. When the value reaches $15, you purchase the maximum amount for $5 each and make a gain of $1,000. When you exercise your option, then the amount of profit, even if the shares are not sold, is added to your regular income for the year. If you hold the stock for more than a year, you will incur a long-term capital gains tax when you sell it.

Tax Deferral

If you already own stock and you sell it to exercise your employer's non-qualified stock option, then your profit on the company shares is not reported and is deferred until you sell them. The Internal Revenue Service considers it an exchange. However, if you purchased new shares of stock at the same time, then the automatic profit you gain is reported to the IRS as income.

Risk of Forfeiture

You may defer taxes on your non-qualified stock options if you face a "substantial risk of forfeiture." In other words, if there is a chance that you will not be able to use your profit, then you don't have to pay taxes on it. For example, if you hold company shares, but your employer has the right to buy them back from you at the original price if you leave the company within a certain period of time, then you do not have to report your earnings until that time elapses and it is no longer a risk.

About the Author

Carol Deeb has been an editor and writer since 1988. Her work has appeared in magazines, newspapers and online publications, as well as a book on education. Deeb is a real-estate investor and business owner with professional experience in human resources. She holds a Bachelor of Arts in English from San Diego State University.