The tax difference is that the long-term capital gains rate is 15% and marginal income tax rates are in the 30-40% range.
With ISOs, if you have a qualifying disposition, you get long-term capital gains on the entire spread between strike price and sell price. With NSOs you have to to pay regular income tax at the spread that exists at time of purchase: http://www.investinganswers.com/financial-dictionary/options...
This can be huge if shares are exercised post-IPO. For example, imagine you have an option with a strike price of $10. Your company goes public at $110 and stays roughly there for a year. With an ISO, if you exercise the option when the company goes public and sell it after a year for $110 you owe $15 of tax. With an NSO you are paying $30-40 of tax at time of purchase. This means you pay 25% more tax on the NSO.
Yes, there are AMT issues ignored in this analysis, but these work out to net-neutral once you account for AMT credits. This also ignores other benefits of ISOs such as not needing to come up with the funds for tax in order to exercise and secure your share. If you do owe AMT, Uncle Sam only charges 3-4% interest: https://proconnect.intuit.com/proseries/articles/federal-irs...
With ISOs, if you have a qualifying disposition, you get long-term capital gains on the entire spread between strike price and sell price. With NSOs you have to to pay regular income tax at the spread that exists at time of purchase: http://www.investinganswers.com/financial-dictionary/options...
This can be huge if shares are exercised post-IPO. For example, imagine you have an option with a strike price of $10. Your company goes public at $110 and stays roughly there for a year. With an ISO, if you exercise the option when the company goes public and sell it after a year for $110 you owe $15 of tax. With an NSO you are paying $30-40 of tax at time of purchase. This means you pay 25% more tax on the NSO.
Yes, there are AMT issues ignored in this analysis, but these work out to net-neutral once you account for AMT credits. This also ignores other benefits of ISOs such as not needing to come up with the funds for tax in order to exercise and secure your share. If you do owe AMT, Uncle Sam only charges 3-4% interest: https://proconnect.intuit.com/proseries/articles/federal-irs...