A type of employee stock option that has the specific benefit of taxation at a capital gains rate as opposed to taxation at ordinary income tax rates whenever the option is exercised.
Attracting top talent to interesting companies is often a challenge. Retaining top talent long-term is even more of a challenge. In an effort to entice talent to remain with a company for more than a few years, corporations will sometimes offer incentive stock options. These benefits are offered as rewards for loyalty and contributions to a company over time. They are also sometimes used as a way to attract talent to startups when competitive base salaries cannot initially be made available.
When an incentive stock option is exercised, it is taxed at a favorable capital gains rate. However, employees must generally wait a significant period of time for these options to vest before they may be exercised at the strike price listed during the grant date. If all goes according to plan, the shares will have become more value by the time they have vested.
Taxation requirements are deferred until the stocks in question are sold. At that time, the taxation rate will be calculated based upon the price difference between the grant date and the date the option was exercised.
Friend One: “Why are you thinking about taking the job at Google when Apple is offering to give you a much better salary?”
Friend Two: “Well, I like Mountain View better than Cupertino. Plus, the salary at Google is lower but the company is offering me a significant incentive stock option. Now that the kids are in school, it seems like a good idea to put down some roots.”