How to Calculate the Short-Term Capital Gains Tax for Disqualifying Dispositions

by Alia Nikolakopulos

A disqualifying disposition occurs when you sell certain employee stock options before required holding conditions are met. If you hold the stock for less than one year from the date the stock was transferred to you, or less than two years from the date the option was granted to you — whichever is later — you have a disqualifying disposition. Capital gains for these transactions are treated as short-term gains and are taxed at your ordinary income tax rate.

1. Determine the market value of the shares you purchased when you exercised your employee stock options. This information is available from the company you purchased the stock from, your investment broker, or through Internet finance sites that publish historical stock data. Multiply the market value per share by the number of shares you purchased. If you purchased shares on various dates, you must perform the calculation for each date separately, using historical data for each different date.

2. Calculate your basis in the stock. Your basis includes the amount you paid for each share, plus the Form W-2 compensation you received upon the disqualifying disposition of your stock. The W-2 compensation you receive is the difference between the price you paid for the stock and the market value of the stock at the time of purchase. If the difference is not included on your W-2, you must still add the amount to your basis.

3. Subtract your cost basis from the sales price of your shares when you dispose of the stock. If the result is positive, you have a short-term capital gain.

4. Calculate and report your income from all sources on your federal income tax return. Ordinary tax is shown on the tax tables for your filing status and taxable income shown on Form 1040, line 43.