An Incentive Stock Option (ISO) is a type of employee stock option that provides favorable tax treatment to the recipient compared to a non-qualified stock option (NQSO). ISOs are granted to employees of a company and give the recipient the right to purchase a specified number of shares of the company's stock at a predetermined price, known as the "exercise price," within a specified period of time.
The main advantage of ISOs is that they are eligible for favorable tax treatment, as long as the recipient holds the stock for at least one year after exercise and two years after the grant date. If these conditions are met, the recipient will pay long-term capital gains tax on any profit made when selling the stock, rather than ordinary income tax.
It's important to note that ISOs are subject to certain restrictions and limitations, such as annual limits on the number of options that can be granted and restrictions on transferring the options to others. Additionally, if the recipient decides to exercise the option and sell the stock before meeting the required holding periods, the profit made from the sale will be subject to ordinary income tax, plus a penalty.
In summary, ISOs can be a valuable benefit for employees, offering a potential source of tax-advantaged investment gains, but it's important to understand the rules and restrictions that apply.