The ISO is in your w2 box as wages. That same dollar amount is what creates your basis- plus fees. Since you are showing the w2 income as basis, it is being reported so that you are only being taxed on it as wages, not as both wages and stock options. When you sell the ISO, you will enter the correct basis so that you are not double taxed on the same income.
Don't forget, the AMT that goes along with the ISO as well along with the potential $100,000 limitation. If you know you are getting ISO, you always want to plan ahead for the tax and alternative minimum tax.
See Topic No. 427 Stock Options
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