You are taxed on your capital gains, as with any stock you purchase. Capital gains tax applies on the amount of your gains above your tax basis after exercise. Long-term capital gains rates apply when you hold the stock more than one year after exercise.

Example: You receive a grant of NQSOs and exercise them after vesting.
  • Your exercise price is $12.
  • The market price (used to calculate the spread at exercise) is $18.
  • You sell the stock when the price is $26.
  • You have $6 per share ($18 – $12) of ordinary income at exercise.
  • You sell the shares more than one year later.
  • You have $8 ($26 – $18) of capital gains at sale.
  • The capital gains are taxed at 15% or 20%, depending on your income.

On your tax return, you report capital gains with Form 8949 and Schedule D of IRS Form 1040. For details, including annotated examples of the tax-return reporting for sales of NQSO stock, see the Tax Center. Should you instead sell the stock at a loss, you will have a capital loss.