Definition of Incentive Stock Options

Some employees receive an incentive stock option---or ISO.

An employee stock option allows the holder to buy a specific number of shares of an employer's stock. An incentive stock option, also known as an ISO, is one common type of employee stock option.

Function

An ISO is an employee stock option with tax benefits. CNNMoney.com states that an ISO is a qualified stock option that is typically offered to upper-level management.

Benefits

The holder does not pay ordinary income tax, and options are taxed at the capital gains rate. The Wall Street Journal's Smart Money reveals that as long as the holder doesn't sell the stocks received, there is not requirement to immediately pay taxes. Taxes must be paid when the employee sells, but the transaction may qualify for the maximum rate of 15 percent on long-term capital gains.

Considerations

SmartMoney.com states that if the employee doesn't follow holding rules, the ISO loses its favorable tax treatment. The other type of tax treatment is a non-qualified stock option, or NSO.

Though the ISO is often perceived as more desirable, it often requires employees to hold the stock for a longer period of time to receive beneficial tax treatments.

References

• CNNMoney.com: Money 101- Lesson 10: Employee Stock Options
• Wall Street Journal Digital Network- Smart Money: Taxes on Incentive Stock Options