Stock options granted to employees that are taxed as capital gains rather than income if the employee meets the required holding period before selling them. Also called statutory stock options and qualified stock options. [Go to source

ISOs are considered tax-advantaged stock options. When you exercise, you are not liable for ordinary income tax provided you hold the stock for at least one year after the exercise date and two years after the grant date. You are liable for capital gains taxes when you sell the shares at a gain, i.e. the difference between the market price on the exercise date and the sale price. Additional tax consequences may be applicable. Please contact your tax advisor with any questions.

When the exercise price is set higher than the market price at the time of the grant to add incentive to improve shareholder value