---
title: ISO (incentive stock option) — what it means and why it matters | Allocate AI
description: A type of employee stock option with special tax treatment: no regular income tax when you exercise, and possible long-term capital gains if you hold.
canonical: https://allocateai.io/glossary/iso
site: Allocate AI — https://allocateai.io
---

# ISO (incentive stock option)

A type of employee stock option with special tax treatment: no regular income tax when you exercise, and possible long-term capital gains if you hold.

An incentive stock option gives you the right to buy company shares at a fixed strike price. What sets ISOs apart from other options is tax treatment. When you exercise, the difference between the strike price and the current value (the spread) is not taxed as ordinary income the way it is with other options.

The catch is the alternative minimum tax. The spread does count as income under AMT rules. Exercise 10,000 shares at a $2 strike when they are worth $20, and you have a $180,000 AMT adjustment even though you received no cash. For a private company where you cannot sell, that can mean a real tax bill on paper gains.

If you hold the shares at least two years from the grant date and one year from exercise, the whole gain from strike to sale price is long-term capital gain, taxed at lower rates. Sell sooner and the spread becomes ordinary income. Only the first $100,000 of options (by strike value) that become exercisable in a year can be ISOs; the rest are treated as NSOs.

The common mistake is exercising a large block late in the year without running the AMT numbers. Many people exercise in smaller pieces, or early in January, to see the full-year picture before committing.

## Related terms

- [NSO (non-qualified stock option)](https://allocateai.io/glossary/nso) — A stock option where the gain between your strike price and the share value is taxed as ordinary income the moment you exercise.
- [AMT (alternative minimum tax)](https://allocateai.io/glossary/amt) — A parallel tax calculation with fewer deductions and its own rates; you pay whichever is higher, and exercising incentive stock options often triggers it.
- [Strike price (exercise price)](https://allocateai.io/glossary/strike-price) — The fixed price at which a stock option lets you buy a share, set when the option is granted, no matter what the stock is worth later.
- [83(b) election](https://allocateai.io/glossary/83b-election) — A form filed within 30 days of receiving restricted stock that lets you pay tax on its value now, while it is low, instead of later as it vests.

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