Definition Compensatory stock options come in two flavors, incentive stock options (ISOs) and non-qualifying stock options (NQOs, or NQSOs). Confusingly, lawyers and the IRS use several names for these two kinds of stock options, including statutory stock options and non-statutory stock options (or NSOs), respectively.
In this Guide, we refer to ISOs and NSOs.
Incentive stock option, ISO
Non-qualifying stock option, NQO, NQSO, NSO
Companies generally decide to give ISOs or NSOs depending on the legal advice they get. It’s rarely up to the employee which they will receive, so it’s best to know about both. There are pros and cons of each from both the recipient’s and the company’s perspective.
ISOs are common for employees because they have the possibility of being more favorable from a tax point of view than NSOs.
cautionISOs can only be granted to employees (not independent contractors or directors who are not also employees).
But ISOs have a number of limitations and conditions and can also create difficult tax consequences.