TLDR:
An ISO is a type of employee stock option that qualifies for favorable tax treatment in the US — gains are taxed at long-term capital gains rates rather than as ordinary income if holding requirements are met.
ISO Qualifying Disposition Requirements
To receive favorable capital gains tax treatment on ISO gains, the holder must satisfy both a two-year holding period from the grant date and a one-year holding period from the exercise date. Failing either requirement constitutes a ‘disqualifying disposition’ and causes the gain to be taxed as ordinary income rather than capital gains — eliminating the tax advantage of ISOs entirely. Many employees inadvertently trigger disqualifying dispositions by selling shares immediately after exercise (a same-day sale) without understanding the tax implications.