ISO Disqualifying Disposition Calculator 2026 β Ordinary Income & Capital Gain
Calculate the tax impact of a disqualifying disposition of Incentive Stock Options. See ordinary income (W-2), capital gain or loss, and compare with qualifying disposition.
ISO Grant Details
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Price at which option was granted $
Stock price on the day you exercised $
Price at which you sold the shares Dates & Tax Rates
%
$0
Ordinary Income (W-2)
$0
Capital Gain / (Loss)
$0
Total Federal Tax
$0
After-Tax Proceeds
ISO Disqualifying Disposition Breakdown
How ISO Disqualifying Dispositions Work
When you sell ISO shares before meeting both holding periods, the bargain element (the spread between FMV at exercise and your exercise price) is treated as ordinary W-2 income β not as capital gains. The ordinary income amount is capped at your actual gain if the stock declined after exercise.
The Formula
Bargain Element = (FMV at Exercise β Exercise Price) Γ Shares
Actual Sale Gain = (Sale Price β Exercise Price) Γ Shares
Ordinary Income = MIN(Bargain Element, Actual Sale Gain)
Capital Gain/(Loss) = Actual Sale Gain β Ordinary Income
(Capital gain portion is short-term if held less than 1 year from exercise)
Actual Sale Gain = (Sale Price β Exercise Price) Γ Shares
Ordinary Income = MIN(Bargain Element, Actual Sale Gain)
Capital Gain/(Loss) = Actual Sale Gain β Ordinary Income
(Capital gain portion is short-term if held less than 1 year from exercise)
Example
1,000 shares, exercise price $10, FMV at exercise $45, sale price $60:
Bargain element: ($45 β $10) Γ 1,000 = $35,000
Actual gain: ($60 β $10) Γ 1,000 = $50,000
Ordinary income: MIN($35,000, $50,000) = $35,000 W-2 wages
Capital gain: $50,000 β $35,000 = $15,000 capital gain
Bargain element: ($45 β $10) Γ 1,000 = $35,000
Actual gain: ($60 β $10) Γ 1,000 = $50,000
Ordinary income: MIN($35,000, $50,000) = $35,000 W-2 wages
Capital gain: $50,000 β $35,000 = $15,000 capital gain
Sources and References (click to expand)
- IRC Section 422 β Incentive Stock Options
- IRC Section 421 β General Rules for Statutory Options
- IRS Publication 525 β Taxable and Nontaxable Income
- Treasury Regulation 1.422-1 β Incentive Stock Options: Exclusion from Gross Income
- IRS Form 3921 Instructions β Exercise of an Incentive Stock Option
Extended
Qualified vs Disqualified ISO Comparison
Side-by-side tax analysis for qualifying vs disqualifying ISO disposition β SVG bar chart, multi-grant scenario table
Compare the tax under qualifying (held both periods) vs disqualifying disposition for the same ISO grant. Add multiple grants to see cumulative impact.
After-Tax Proceeds: Qualified vs Disqualified
| Grant | Shares | Total Gain | Tax (Qualified) | Tax (Disqualified) | Advantage of Qualifying |
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Frequently Asked Questions
What makes an ISO disposition disqualifying?
An ISO disposition is disqualifying if you sell the shares before meeting BOTH holding period requirements: (1) more than 2 years from the grant date, AND (2) more than 1 year from the exercise date. Selling before either deadline triggers ordinary income treatment on the bargain element instead of favorable long-term capital gains treatment.
What is the "bargain element" in an ISO?
The bargain element is the difference between the fair market value (FMV) of the stock at the time of exercise and the exercise price you paid. For example, if you exercised at $10/share when FMV was $50/share, your bargain element is $40/share. In a disqualifying disposition, the lesser of (a) the bargain element at exercise or (b) the actual gain at sale is treated as ordinary W-2 income.
How is the ordinary income calculated in a disqualifying disposition?
Ordinary income equals the LESSER of: (1) the spread at exercise (FMV at exercise minus exercise price), or (2) the actual gain at sale (sale price minus exercise price). If the stock dropped in value after exercise, you only recognize ordinary income up to the actual gain β the rest is a capital loss.
Does the employer withhold taxes on a disqualifying disposition?
Yes. The employer must report the ordinary income portion as W-2 wages and withhold FICA taxes (Social Security and Medicare). Federal and state income tax withholding also applies. The employer receives a compensation deduction equal to the ordinary income recognized by the employee.
What are the benefits of qualifying vs disqualifying ISO dispositions?
A qualifying disposition (holding both periods) results in: no ordinary income, no W-2 reporting, no FICA, and all gain taxed at favorable long-term capital gains rates. A disqualifying disposition loses all these benefits β the bargain element becomes ordinary W-2 income. However, a disqualifying disposition also avoids the Alternative Minimum Tax (AMT) that applies at ISO exercise.