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Let's say one is being given employee stock options with a relatively low exercise price, such that it makes sense to do an 83(b) early exercise. In that case, would it matter if they are incentive stock options (ISOs) or non-qualified stock options (NQSOs) from the perspective of the recipient? Since they will all be exercised with fair market value (FMV) equal to exercise price, there is no income realized, either for AMT or regular income tax purposes. And after the exercise, they become shares with a basis of the exercise price. So would it matter at all if they started out as ISOs or NQSOs?

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I believe that the long-term capital gains holding periods are different. For an early-exercised NQSO, it would be treated as long-term capital gains if you hold it for 1 year after exercise, but for an early-exercised ISO, it would only be treated as long-term capital gains if you hold it for 1 year after vesting.

Also, I believe early-exercised ISOs have to be held for two years from grant in order to not trigger a "disqualifying disposition". If a "disqualifying disposition" occurs, then the gain up to vesting will be taxed as compensation, and only the gain after vesting treated as capital gains. No such issue exists with early-exercised NQSOs.

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  • Interesting, so NQSOs are actually superior in both regards to ISOs, assuming early exercise?
    – Craig W
    Nov 17, 2021 at 21:57
  • @CraigW: yes . .
    – user102008
    Nov 18, 2021 at 17:36

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