Payroll taxes on exercised stock options

Question

The company I work for was recently sold. As part of the buyout, non-qualified stock options held by certain employees were exercised and sold immediately to the buyer. Since multiple employees were exercising their options, this was handled by the finance departments of my company and the buyer.

My gross payout (share price less option price + fees) was paid out via a standard payroll statement as a "non-qualified stock options" line item. Taxes were deducted from this payout at the same income tax rates I see on all pay statements (e.g. 7.65% Social Security tax, 2.5% city tax, my usual state tax rate, etc.).

So now I have a net payout amount sitting in my bank account, and I'm concerned I may have additional taxes to account for when I file next year. I haven't been able to find much information on how non-qualified stock options should or shouldn't be treated as income tax - most articles mention capital gains tax.

Are the income tax deductions already taken out of my NQ options payout adequate and appropriate? Are there any potential extra taxes on this income?

Answer 1

The trickiest thing is the federal tax. It's typical to withhold 25% federal on this type of event. If your federal marginal rate was already towards the top of that bracket, you'll owe the missing 3% as you enter the 28% bracket. Nothing awful, just be aware.

Answer 2

To explain the capital gains part of the question, non qualified stock options (NSOs) are always treated like earned income and have payroll taxes withheld. It's advantageous for the company to issue these because they can deduct them as expenses just as they do your salary.

Articles talking about capital gains would probably be referring to incentive stock options (ISOs) or possibly even restricted stock units (RSUs). If you were granted the option to buy the stock and/or hold it for a period of time, then the stock options could be treated as capital gains, short-term gains if you held them for less than a year, and long-term gains if you held them for more than a year.

This payment for your NSOs is exactly like a cash bonus. The withholding follows the same guidelines. You may wish to look at what this will mean for your annual salary and adjust your W-4 withholding up or down as appropriate depending on whether the 25% federal withholding rate is more or less than what you think your final marginal rate will be with this bonus included in your annual salary.