Incentive stock options (ISO) refer to a set of stock options used by corporations to compensate major employees in a way that generates limited tax obligations for the employee. If structured and used correctly, an ISO can be taxed as capital gains instead of regular income, greatly reducing the tax liability that increased salary otherwise would generate. However, like with other stock options, the employee runs the risk of losing money if the stock value drops below the price set in the option.
There are many requirements on using ISOs. First, the employee must not sell the stock until after two years from the date of receiving the options, and they must hold the stock for at least a year after exercising the option like other capital gains. Secondly, the stock option must last ten years. Thirdly, the stock option must be non-transferable by the employee. Fourthly, the employee must remain an employee from the date of receiving the options to three months before exercising the options. These are just some of the main requirements, but other regulations must be met to receive the beneficial treatment. For more of the regulations on using ISOs, see the IRS guidance here.
[Last updated in March of 2022 by the Wex Definitions Team]