ISO

TL;DR

A US tax-advantaged stock option for W-2 employees, eligible for long-term capital-gains treatment if holding-period requirements are met.

ISOs are a US-only option type with potential preferential tax treatment. If an employee exercises an ISO and holds the underlying shares for at least two years from grant and one year from exercise, gains are taxed at long-term capital gains rates instead of ordinary income. The downside: exercising ISOs can trigger Alternative Minimum Tax (AMT) on the spread between strike price and FMV.

ISOs are limited to W-2 employees (no contractors, advisors, or board members), capped at $100K in exercise value per year per person, and must be granted at fair market value (set by 409A).

Worked example

An employee receives 10,000 ISOs at $1.00 strike. They exercise at $5.00 FMV. AMT preference = (5 − 1) × 10k = $40k. If they hold 1 year past exercise + 2 years past grant before selling at $20, the $190k gain is taxed long-term capital gains, not ordinary income.

Common pitfalls

• Exercising large ISO grants without modeling AMT exposure.
• Granting ISOs to non-employees in error.
• Letting the 90-day post-termination exercise window lapse without action.

When this shows up in a pitch deck

Equity compensation structure is hiring and diligence content, not deck content.

Related terms

• NSO — Non-Qualified Stock Options — a more flexible US option type than ISOs, available to contractors and advisors but without the same tax-advantaged treatment.
• RSU — Restricted Stock Units — equity compensation that vests into shares without requiring exercise, common at late-stage and public companies.
• Strike Price — The fixed price at which an option holder can purchase a share, set at fair market value on the grant date and locked in for the option's life.
• 83(b) Election — A US tax election letting restricted-stock recipients pay tax on the grant-date value (not at vesting), often saving early-stage founders meaningful tax.
• ESOP — Employee Stock Option Plan — the legal structure that lets a company grant options to employees at a defined strike price, governed by board approval and 409A.

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