What is it
A non-qualified stock option is the standard form of Stock Option, taxed under the general rules that apply to most compensation. When you exercise an NQSO, the spread between the strike price and the stock’s fair market value that day is taxed as ordinary income. Your employer generally applies tax withholding and payroll taxes to it, as it would to wages. Any further gain after exercise is taxed as a capital gain when you sell the shares. The other main type, the incentive stock option (ISO), is a tax-favored exception that applies only when specific conditions are met.
What does it matter:
With an NQSO, exercising is a tax event: the spread is taxed in the year you exercise, whether or not you sell the shares. At a public company, a cashless exercise can cover both the exercise cost and the tax by selling some shares on the spot. At a private company, there’s usually no market to sell into, so exercising can require cash for both the shares and the tax.
What do people most often get wrong:
People often read "non-qualified" as a sign that the option is worth less or that something about it is wrong. The label only means the option isn't set up to meet the conditions for ISO treatment. The NQSO is the default, not a downgrade. An NQSO and an ISO with the same strike price and share count produce exactly the same spread. What differs is when that spread is taxed and at what rate.