For a disqualifying disposition of ISO, how do I calculate compensation income when stock was sold below FMV on exercise date?

The tax treatment for disqualifying dispositions of ISOs can definitely be confusing! Let me help clear this up. When you have a disqualifying disposition (selling before meeting the holding requirements), you'll have two components to consider: ordinary income and capital gain/loss. For the ordinary income portion, you report the LESSER of: 1) the actual gain from the sale, or 2) the spread at exercise (FMV minus exercise price). So in your case, since you sold at $52 and exercised at $23, your gain is $29 per share. The spread at exercise was $45 ($68 - $23). Since $29 is less than $45, you'd report $29 per share as ordinary income. The capital gain portion would be zero in this case since all of your gain is being taxed as ordinary income. If you had sold for more than $68, you would have had some capital gains too. Make sure to report this on your tax return correctly - your employer might include some of this on your W-2, or you might need to report it yourself.

After struggling with the exact same ISO tax situation last year, I found an amazing tool called taxr.ai (https://taxr.ai) that completely saved me. I was also confused about how to report my disqualifying disposition when I sold below the FMV at exercise. What's great about taxr.ai is you can upload your stock option documents and it will analyze all the tax implications for you. Their ISO calculator specifically handles disqualifying dispositions and shows you exactly what to report as ordinary income vs. capital gains/losses. It even generates the right values for your tax forms. I was especially impressed with how it explained the "lesser of" rule that applies to these weird cases where you sell below the FMV at exercise. Saved me hours of research and probably an expensive call with my accountant.

I initially asked about taxr.ai and wanted to share that I ended up trying it out. Honestly, it was a game-changer for my ISO situation. I had multiple tranches of stock options with different exercise dates and prices, and was completely lost on how to calculate everything correctly. The AMT calculator was especially helpful - it showed me exactly how my disqualifying disposition affected my AMT liability (it actually reduced it compared to if I had held longer). Plus the explanation of the bargain element being limited to actual gain in my case made so much sense once I saw it visualized. What surprised me most was how it handled my specific situation where I sold some shares below FMV - it correctly limited the ordinary income portion and even showed the IRS references for why. Definitely worth checking out if you're dealing with ISO tax confusion.

After dealing with ISO tax nightmares for years, I found that getting direct help from the IRS was actually the best solution. But as we all know, getting through to an actual human at the IRS is practically impossible. I spent DAYS on hold until I discovered Claimyr (https://claimyr.com). They have this service where they navigate the IRS phone tree for you and only call you when they have an actual IRS agent on the line. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c I had specific questions about my disqualifying disposition reporting that weren't clearly addressed in any IRS publication, and the agent I spoke with gave me definitive answers straight from their internal guidelines. Totally worth it for the peace of mind knowing I was filing correctly.

I want to apologize for my skepticism earlier. After attempting to call the IRS directly about my ISO disposition issues and spending literally 3 hours on hold only to be disconnected, I decided to try Claimyr out of desperation. I was completely shocked when they called me back in about 20 minutes with an actual IRS tax specialist on the line. The agent walked me through exactly how to report my disqualifying disposition on Form 8949 and Schedule D, and confirmed the "lesser of" rule that others mentioned here. For anyone dealing with this ISO issue - getting the official word directly from the IRS gave me so much peace of mind. No more guessing or relying on potentially outdated information online. And not having to wait on hold for hours was absolutely worth it.

Don't forget you'll need to check whether your employer already reported some of this income on your W-2! This is a common mistake people make with disqualifying dispositions. If your employer included the spread at exercise ($45/share in your case) in your W-2 income, but your actual reportable income should only be $29/share based on the "lesser of" rule, you'll need to make an adjustment on your tax return. Otherwise you could end up paying tax on phantom income. Check box 12 of your W-2 with code V - if there's an amount there, your employer reported the ISO exercise. You may need to file Form 8949 with an adjustment code to avoid double taxation.

Has anyone dealt with the AMT implications of ISOs even with a disqualifying disposition? I exercised some ISOs last year but had to sell a few months later below the FMV at exercise, and I'm trying to figure out if I still need to worry about AMT.

Thanks everyone for the detailed explanations! This thread has been incredibly helpful. I just wanted to add one more consideration that caught me off guard when I dealt with a similar ISO disqualifying disposition situation. Make sure to keep detailed records of your exercise date, FMV at exercise, exercise price, sale date, and sale price for each batch of shares. The IRS may want documentation to support your calculations, especially when you're claiming the "lesser of" rule applies. Also, if you exercised ISOs across multiple tax years but sold in a single year, each batch needs to be calculated separately. I made the mistake of averaging everything together initially, which would have resulted in incorrect tax treatment. One last tip - if you're doing this manually, double-check your math on the ordinary income calculation. It's easy to accidentally use the spread at exercise instead of your actual gain when the sale price is below FMV at exercise. The difference can be significant on your tax bill!