Test Your Knowledge: NEW! NQSOs Quiz
Test your knowledge of nonqualified stock options (NQSOs).

Please answer the following 10 questions. This quiz is also a course of study. The answer key links to content on the topic for follow-up reading

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1. What is a nonqualified stock option (NQSO)?

An option to be paid in stock instead of cash
A right to buy company stock at a nonqualified discount for a fixed term
A right to buy company stock at a specified price for a fixed term with special benefits under the tax code
A right to buy company stock at a specified price for a fixed term but without special benefits under the tax code

2. What is the legal limit of the NQSO grant term?

There is no limit, though option terms are seldom longer than 10 years
The option term cannot extend beyond one year after vesting
10 years, unless your employment ends sooner
10 years, regardless of whether your employment ends

3. When are NQSOs taxed?

At grant
At exercise
At sale
They are exempt from tax (i.e. nonqualified)

4. Why might a grant of NQSOs be better than a grant of restricted stock or RSUs?

Stock options have guaranteed value
Stock options have no vesting period, so you don't have to wait to exercise them
With a rising stock price over a long term, stock options offer greater investment leverage and potential gains
All of the above

5. With a rising stock price, why do financial planners sometimes recommend waiting to exercise NQSOs until near the end of the option term?

The longer you wait, the bigger their fee
Taxes on stock-price appreciation above the exercise price are deferred until NQSO exercise
Inflation means your grant is worth more in real terms after several years
US tax rates always decrease over the long term

6. When you exercise NQSOs, the spread is taxed as what type of income?

Capital gain
Investment income
Occasional income
Ordinary income

7. How long must you hold NQSO shares to have the gains taxed as long-term capital gains?

Eighteen months, starting on the day after exercise
One year, starting on the day after exercise
Six months from the exercise date
Two years from the exercise date

8. Is the income from an employee’s NQSO exercise reported on Form W-2?

Never (reported instead on Form 1099-MISC)
Only if you choose to have taxes withheld
Only if you sell the shares at exercise

9. Which two IRS forms are used for reporting capital gains on your tax return after you have sold NQSO shares?

Form 1040 and Form 1099-B
Form 1040 and Schedule D
Schedule C and Form 8949
Schedule D and Form 8949

10. For a sell-to-cover NQSO exercise, how do you report the stock sale on your tax return?

Report the number and tax basis of the shares exercised that are part of the W-2 income, not just the number of shares sold and their tax basis
Report only the number of shares sold and their tax basis, not the number and tax basis of the shares exercised that are part of the W-2 income
Report the exercise income included on the W-2
Report the exercise income on the W-2 minus the tax basis

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