Qualifying and Disqualifying Disposition
ISO’s (Incentive Stock Options) can either be qualified for or disqualified from the tax benefit of not having to pay ordinary income tax. In order to qualify for the tax benefit, it must meet both of the holding period requirements: 1) Sale date must be 2 years after grant issue date AND 2) Sale date must be 1 year after exercise date. If the shares sold do not meet these holding periods, they will be considered disqualified and will be subject to ordinary income tax. If the shares sold meet the holding periods, they will be considered qualified, you will not pay ordinary income tax, and you will only have to pay long-term capital gains tax.
In the case of NSO's (Non-Qualifying Options), you will always pay ordinary income tax when you exercise, at which point they become Common shares. After the date of exercise, you will either pay short-term capital gains tax (if the shares have been held for 1 year or less) or pay long-term capital gains tax (if the shares have been held for over a year).
ESPP's work similarly. Holding periods are 1) Sale date must be 2 years after offer date AND 2) Sale date must be 1 year after purchase date.