The upside to ISOs is that you can strategically save on taxes. But it can be a bit tricky to know exactly how!
How can I save on taxes with ISOs?
If you have a qualifying disposition (sale) of your ISOs, you can pay long-term capital gains tax on the appreciation of your options rather than the (much more costly) ordinary income tax
For example, let's say you make a total of $100,000 each year. This means that your ordinary federal income tax rate is 32% and your long-term capital gains tax rate is 15%
Let's say you exercise and then immediately sell 10,000 shares with a grant price of $1 per share and a current fair market value of $20 per share
Qualifying Dispositions of ISOs
In order to 'qualify' for preferential tax treatment on the appreciation of your ISOs, the stock acquired most be sold at least one year after the stock was exercised
Also, the stock acquired must be disposed (sold) at least two years after the grant date.
Taxation Timeline
Here is a visualization of what must be done to get the long-term capital gains tax treatment with ISOs:
