editione2.1.1
Updated September 12, 2022βDefinitionβ 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.
| Type | Also called |
|---|---|
| Statutory | Incentive stock option, ISO |
| Non-statutory | Non-qualifying stock option, NQO, NQSO, NSO |
Companies generally decide to give ISOs or NSOs depending on the legal advice they get. Itβs rarely up to the employee which they will receive, so itβs best to know about both. There are pros and cons of each from both the recipientβs and the companyβs perspective.
ISOs are common for employees because they have the possibility of being more favorable from a tax point of view than NSOs.
βcautionβ ISOs 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.
βDefinitionβ Sometimes, to help reduce the tax burden on stock options, a company will make it possible for option holders to early exercise (or forward exercise) their options, which means they can exercise even before they vest. The option holder becomes a stockholder sooner, after which the vesting applies to actual stock rather than options. This will have tax implications.
βcautionβ However, the company has the right to repurchase the unvested shares, at the price paid or at the fair market value of the shares (whichever is lower), if a person quits working for the company. The company will typically repurchase the unvested shares should the person leave the company before the stock theyβve purchased vests.