meaning of qualifying/disqualifying distribution as separate from capital gains implications

Question

I have an ESPP and am trying to figure out the difference between a qualifying and disqualifying distribution. I have read the explanation from Intuit here: https://turbotax.intuit.com/tax-tools/tax-tips/Investments-and-Taxes/Employee-Stock-Purchase-Plans/INF12047.html

Disqualifying Disposition:

You sold the stock within two years after the offering date or one year or less from the exercise (purchase date). In this case, your employer will report the bargain element as compensation on your Form W-2, so you will have to pay taxes on that amount as ordinary income. The bargain element is the difference between the exercise price and the market price on the exercise date. Any additional profit is considered capital gain (short-term or long-term depending on how long you held the shares) and should be reported on Schedule D.

Qualifying Disposition:

You sold the stock at least two years after the offering (grant date) and at least one year after the exercise (purchase date). If so, a portion of the profit (the “bargain element”) is considered compensation income (taxed at regular rates) on your Form 1040. Any additional profit is considered long-term capital gain (which is be taxed at lower rates than compensation income) and should be reported on Schedule D, Capital Gains and Losses.

But I feel like I am taking crazy pills because the actual tax implications may not necessarily be different, if I am reading this right. A qualifying distribution seems guaranteed to fall under long term capital gains. But a disqualifying distribution could also fall under long term capital gains depending on when it is sold. So what's the actual change that occurs once something becomes a qualifying as opposed to a disqualifying distribution?

Answer 1

A qualifying distribution seems guaranteed to fall under long term capital gains. But a disqualifying distribution could also fall under long term capital gains depending on when it is sold. So what's the actual change that occurs once something becomes a qualifying as opposed to a disqualifying distribution?

Yes a qualifying distribution always falls under long term capital gain.

The difference between qualifying and disqualifying is how the "bargain element" of benefit is calculated. In case of disqualifying distribution it is always the discount offered, Irrespective of the final sale price of the stock.

In case of qualifying distribution it is lower of actual discount or profit. Thus if you sell the stock at same price or slightly lower price than the price on exercise date, your "bargain element" is less. This is not the case with disqualifying distribution.