Incentive Stock Option (ISO)
While otherwise similar to a non-qualified stock option, an incentive stock option has tax-saving features that an NSO does not have.
Under the regular tax rules, when you exercise an ISO, any gain in value resulting from an increase in the stock price above the strike price is not taxed. The gain is taxed when you sell the shares.
If you hold the shares for two years from the date you received your option and one year after you exercised your option, then any gain will be taxed at the long-term capital gain tax rates instead of the higher ordinary income tax rates.
However, under alternative minimum tax (AMT) rules, the gain is taxed when you exercise your option, which depending on your individual circumstances, can negate much of the regular tax savings.
As with non-qualified stock options, there are no tax costs when you receive your option under regular income tax or AMT rules.