ISOs (incentive stock options) can only go to employees and get better tax treatment if holding rules are met, but they can trigger AMT at exercise. NSOs (non-qualified stock options) can go to anyone, and the spread between strike price and value is taxed as ordinary income when they are exercised.
Both give the holder the right to buy shares later at a fixed strike price. The strike price has to be at or above the stock's fair market value on the grant date, which is what a 409A valuation sets. A stale or missing 409A is what turns a routine grant into a tax problem for the person receiving it.
A seed-stage startup sets up an option pool. It grants options to its first five employees and to one outside advisor. The employees can get ISOs. The advisor cannot, because ISOs are for employees only, so the advisor gets NSOs.
Both kinds need a strike price at or above the stock's fair market value on the grant date. That is what the 409A valuation sets.
No. ISOs can only go to employees. Advisors, board members who are not employees, and contractors get NSOs.
To keep ISO tax treatment, the option generally has to be exercised within 3 months after employment ends. If it is exercised later, it is taxed as an NSO. Your plan may also set its own deadline.
Not always. ISOs can be taxed at lower rates if the holding periods are met. But the AMT at exercise can be a real cash cost before the shares can be sold. The better choice depends on the person's own tax picture.
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