The differences all have to do with taxes:Defined: More formally known as Qualified Incentive Stock Options (ISOs, aka statutory options) and Non-qualified Stock Options (NSOs or NQSOs). The qualification refers to the special tax treatment that ISOs get. ISOs are only for employees whereas contractors, business partners, as well as employees can get NSOs.AMT or OIT: The main difference is the immediate tax treatment. When you exercise either stock option, there is a spread between the exercise price and the current Fair Market Value (FMV) that is subject to Tax. ISOs receive special tax treatment and are exempted from the immediate ordinary income tax on the spread. However, exercising an ISO is subject to Alternative Minimum Tax (AMT) which comes into play for wealthier tax payers or when the spread is large. In all cases, AMT rates are still lower than OIT rates by definition. Moreover, the NSOs are subject to the high ordinary income tax rate on the spread including Medicare and Social Security Taxes.Expiration: ISOs only apply while you are employed at the company and cannot be extended beyond 90 days after you leave. NSOs donu2019t require employment and can be extended well beyond 90 days. ISOs can only last 10 years before they must be exercised regardless of whether the holder is still employed at the company.Disqualifying Dispositions: If the ISOs are sold during the same tax year as the exercise, then you will pay ordinary income tax on the spread between the exercise price and the actual sale price. This will be a disqualifying disposition and you will no longer be subject to AMT on the spread between the exercise price and the FMV. If an ISO is not sold the same year as the exercise but still within 1 year of the exercise or within 2 years of the grant date, then it is also a disqualifying disposition. In this case, the spread between the exercise and the FMV will be taxed as ordinary income and the spread between the FMV and the final sale price is taxed as a short term capital gain. A qualifying disposition gets long term capital gains treatment and requires the sale to occur more than 1 year after the exercise and more than 2 years after the grant date.Withholding Tax: NSO tax is withheld at the point of exercise whereas the potential AMT on ISOs isn't due until you file taxes next April. However, you can file an 83(i) election to defer NSO taxes for 5 years. Although withholding is mandatory for employees, contractors can get a 1099 and handle their own quarterly estimated taxes. Similarly, disqualifying disposition of the ISOs by selling during the same tax year as the exercise will trigger ordinary income tax which is required to be serviced by quarterly estimated tax payments.Estimated Tax Payments: The minimum NSO exercise withholding requirement is only 22%. Many companies try to ethe right amount but it isn't very easy. When you file your taxes, you will true it up to the required amount. That could result in a refund or additional taxes. Any shortfall subjects you to interest penalties and estimated quarterly taxes. If you sold ISO shares, you are also responsible for paying quarterly estimated taxes which you calculate yourself. If you don't pay enough, there are interest penalties when you file next April.Double Taxation: If you sell ISOs after the tax year of the exercise, then you will be subject to AMT for the year of the exercise AND be subject to capital gains tax on the profits from the sale for that subsequent tax year. Those profits are calculated based on the spread between the final sale price and the FMV and the exercise price (see 4) even if you have paid AMT on the exercise. See this primer for recovering the AMT via credits.Selling the Same Year: In situations when both ISOs and NSOs are sold right away in the same tax year, selling the NSO results in short term capital gains on the profit between the FMV at the time of exercise and the final share price. Since the STCG rate is currently the same as the ordinary income tax rate, it is almost a wash with selling ISOs where profit will be final sale price less the exercise price. Although the tax rates are the same, the difference is that a portion of the income from the sale of NSOs above the FMV will be capital gains which can be offset by other capital losses you may have that tax year. There is no similar offset for the ordinary income tax gains from selling your ISOs during the same year as the exercise. However, the ISO income from the disqualifying disposition isnu2019t subject to Medicare or FICA tax.Reducing AMT: If you exercised the NSOs and paid the proper amount of taxes, your Alternative Minimum Tax (AMT) on any ISOs exercised the same year goes down. This makes your overall optimization challenge to be a good spreadsheet problem. This last scenario means that in a given year involving exercising and selling, you may want to sell the NSOs first because you have a higher cost basis and hold the ISOs for long term capital gains eligibility because the AMT is low or zero.100K Limit: Because of their favorable tax treatment for most people, the amount of ISOs that become eligible for exercise each year is limited to $100,000. This is calculated by multiplying the number of shares that become eligible for exercise (vest) in any given year by the FMV at the time of the grant which is usually the exercise price. This limit causes larger grants to be split into ISOs and NSOs. Individuals who have both should consider item (9) to maximize their benefits.Payroll Taxes: Although ISOs can trigger ordinary income taxes in the cases of a disqualifying disposition, it is still cheaper than the OIT paid on exercising an NSO because Medicare and FICA tax donu2019t apply to an ISO DD.Check here for more ways to save money on stock options: Ways to Reduce Stock Option Taxes