Definition 1.
Incentive Stock Option. A type of employee stock option which provides tax advantages for the employer that a non-qualified stock option does not, but which is subject to more stringent requirements. For ISOs, no income tax is due when the options are granted or when they're exercised. Instead, the tax is deferred until the holder sells the stock, at which time he/she is taxed for his/her entire gain. As long the sale is at least two years after the options were granted and at least one year after they were exercised, they'll be taxed at the lower, long-term capital gains rate; otherwise, the sale is considered a "disqualifying disposition", and they'll be taxed as if they were nonqualified options (the gain at exercise is taxed as ordinary income, and any subsequent appreciation is taxed as capital gains). ISOs may not be granted at a discount to the current stock price, and they are not transferable, except through a will. also called qualified stock option.
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