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Non-qualified stock options (NSOs) give employees the choice to purchase shares at a fixed price. What sets NSOs apart from incentive stock options is that special tax rules do not apply to NSOs. Instead, non-qualified stock options are taxed on the bargain element (i.e. the difference between your exercise price and what the shares are actually worth) at exercise, in the form of regular income taxes.

NSOs are subject to mandatory withholding, so when exercising your NSO shares triggers taxes, you must pay a portion of them immediately in the form of withholding. Supplemental withholding rules also apply to NSOs at the standard federal rate of 22%, often causing gaps between what’s withheld at exercise and what you actually owe come tax time.

Any gains that occur after you exercise your shares are taxed as either short- or long-term capital gains, depending on the holding period.