An incentive stock option (ISO) gives an employee the right to buy company stock under specified tax rules. Startups commonly use ISOs to keep employees invested in staying with the company. section 4.2
The basic sequence is:
- Vesting turns a promise of future stock into options the employee may exercise. section 4.2
- Exercise means paying the strike price to buy vested options and turn them into shares. section 4.2
- Selling shares held for less than a year can make the profit taxable as ordinary income at relatively high employee tax rates. section 4.2
Why the incentive matters
A startup employee receives ISOs, earns more through vesting each month, and must remain with the company to accumulate more options. After exercising, the employee can sell the shares if a buyer exists. section 4.2
