how qualifying disposition works
to be a qualifying disposition the employee must sell their position at least one year after exercising the stock and two years after the incentive stock option iso was granted or two years after the beginning of the espp offering period 1 for example suppose cathy s iso options were granted september 20 2018 and she exercises them september 20 2019 in this scenario cathy must wait until september 20 2020 before she may report a long term capital gain the capital gains treatment for a qualifying disposition applies to the amount of the sale represented by the difference between the exercise price of the option s stock and the market price at which the stock sold for example if tim exercises 1 000 iso options at 10 per share and sells them for 30 per share he consequently will report a capital gain of 20 000 20 x 1000 shares 3 non statutory stock options nsos do not qualify for capital gains tax treatment and are taxed at ordinary income rates 2 issuing a compensation package that includes isos and a qualified espp helps companies attract and retain top tier personnel it also aligns a company s management and key employees with its shareholders as they all want the company to succeed and increase its share price some companies do not offer isos because contrary to non statutory or non qualified option plans there is no tax deduction for the company when the options are exercised 4 special considerations bargain element refers to an option that can be exercised below the current market price which provides the employee with an immediate profit an employee who exercises a non statutory option must report the bargain element as earned income which is subject to income tax it should be noted that employees who hold isos are not mandated to report the bargain element until after they sell their shares 3 the bargain element is reported as ordinary income if the shares were immediately sold after they were exercised a disqualifying disposition by contrast the bargain element is reported as a long term capital gain if the sale was executed one year after exercising the options and two years after the grant date qualifying disposition 3 the bargain element for nsos is added to an individual s alternative minimum taxable income which has a flat tax meant to ensure everyone pays their fair share of taxes despite tax minimization strategies 3 qualifying distribution vs disqualifying distributiona disqualifying distribution is the sale or exchange of shares received from an iso or espp before the holding period has been met the iso holding period is one year from the exercise date and two years from the grant date or two years from the espp offering date gains or losses realized in a disqualifying disposition are taxed at a higher rate 3 if espp or iso shares are sold in a qualifying disposition the bargain amount is taxed at the capital gains rate disqualifying dispositions are recorded at the income tax rate which is generally higher than the capital gains tax 3 