A Nonqualified Stock Option (NSO) is a type of stock option that does not qualify for favorable tax treatment under the Internal Revenue Code. This means that the employee who exercises an NSO must pay ordinary income tax on the difference between the exercise price and the fair market value of the stock at the time of exercise.
NSOs are typically used to compensate employees, directors, and consultants who are not eligible to receive Incentive Stock Options (ISOs). NSOs are simpler and easier to administer than ISOs, but they are subject to more restrictions and can result in higher taxes for the recipient.
In general, the grantor (usually the employer) has the right to determine the exercise price, vesting period, and other terms of an NSO. The recipient does not receive any special tax treatment until they exercise the option and purchase the stock. At that point, the recipient must report the difference between the exercise price and the fair market value of the stock as ordinary income on their tax return.