CCA 201519031 explored the application of the disqualifying disposition
rules in two scenarios: Scenario 1 involves a transaction that qualified as a Sec.
If, on the other hand, the employee sells the stock before the statutory holding period ends, the sale will be a disqualifying disposition
, and the employee will recognize ordinary income, which is taxed at a higher rate.
However, if your short-term goal is to reduce single-stock concentration, a disqualifying disposition
strategy may outweigh the tax benefits of holding the underlying stock.
If a disqualifying disposition
of stock acquired by the exercise of an ISO occurs, the gain from the disposition is determined as follows:
A disqualifying disposition
occurs when the shares are held less than two years after the beginning of the offering period.
Under the new law, gains resulting from the exercise of an incentive stock option or an employee stock purchase plan (ESPP) option, or a disqualifying disposition
of such stock, will not be treated as employment tax wages.
But just 71 percent of companies granting ISOs track disqualifying disposition
, meaning that many companies are losing potentially significant tax deductions.
The first the public heard of this distinction was in Private Letter Ruling 9243026 (June 24, 1992), in which the IRS concluded that FICA and FUTA taxes applied at the time of the ESPP option exercise to the difference between the fair market value of the stock and the exercise price and, further, that federal income tax withholding applied to the income on disqualifying disposition
If an option otherwise qualifies as an ISO, but the optionee disposes of acquired shares prior to expiration of both statutory holding periods (two years after grant and one year after exercise), the optionee is taxed, at the time of the disqualifying disposition
, as if the option were nonstatutory.
But the IRS also determined that the value of the taxpayer's exercisable MGC shares exceeded the $100,000 limit The taxpayer asserted that the $100,000 limitation is only applied to shares that were not subject to a subsequent disqualifying disposition
422(c)(2) limits the compensation income the employee must include as a result of the disqualifying disposition
, to the excess (if any) of the amount realized on the disposition over the stock's adjusted basis.
When a disqualifying disposition
of an ISO occurs when an employee disposes of the stock within two years of the option grant date or within one year of the option exercise date--the company gets a tax deduction equal to the difference between the option's fair value and the exercise price on the date the disqualifying disposition