First, a bit of contrast.  Your Stock Awards (part of your annual review) are pretty easy to deal with tax-wise. The vested award's value appears on your W2 in Box 1, and shows on your paystub as "Stock Award Spread". Taxes on the award are automatically withheld, and those also appear on your W2 in the appropriate Federal, Social Security, and Medicare tax boxes. They're listed on your paystub as "Stock Award taxes."  Easy enough.

Of course, you still have to figure your Capital Gains (or losses) when you sell the awarded stock. We'll get to that in a minute.

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ESPP COMPENSATION VALUE
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Compared to Stock Awards, the tax rules for ESPP are quite complicated. They're also hard to follow because of how Fidelity and your W2 do recordkeeping.

When you actually "buy" ESPP at the end of the offering period, there are no taxes to pay. Great!

Unfortunately, when you sell, the world gets very complicated. The first thing to understand is that, depending on when you sell, you either have made a "Qualifying" or "Disqualifying" Disposition. For Microsoft ESPP, if you sell the ESPP shares within 21 months of buying them, it's a "Disqualifying" Disposition.

Now, "Disqualifying" sounds bad, but it isn't necessarily a problem and actually makes your taxes a fair bit simpler.

When you make a DQDSP sale, you have to account for the "Compensation value" of your ESPP DISCOUNT as "ORDINARY INCOME". For Microsoft, that discount is 10% of the purchase price of the shares. Microsoft keeps track of the DQDSP "Compensation value" on your W2; it appears alone in Box #14, and the value is also added to Box #1.

Being in Box #1 means that DQDSP's "Compensation Value" is counted as a part of your taxable income automatically, which is good. The bad part is that Microsoft doesn't withhold taxes on that taxable income, however, which can lead to unpleasant surprises come tax season.

In contrast, when you make a Qualifying sale (QDSP), your "Compensation value" / ORDINARY INCOME is the lower of:

 1> The Discount you *would have gotten* on the stock, AS IF it would have bought at the *start* of the offering period (aka 3 months before it actually DID buy)
 2> The gain you made when you sold the stock (e.g. Proceeds minus what you paid.)

Depending on how the stock price has moved between the start of the offering period and when you sell it, a QDSP could provide tax advantages OR disadvantages over a DQDSP.

Surprising, eh? It gets worse...

 ** WARNING **
The BIG problem is that Microsoft doesn't keep track of a QDSP's "Compensation value" / "ORDINARY INCOME" for you, and it's not super-easy to go back and calculate it. Once you do calculate it, you have to add it to your W2 Box #1 yourself.

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CAPITAL GAINS / LOSSES
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The "Qualifying" or "Disqualifying" nature of the Disposition controls how much "ordinary" income you have received from the ESPP discount. But when you buy or sell stock, you also have to report the Capital Gain or Loss. To do that, you calculate the proceeds of the sale minus your BASIS cost. Critically for ESPP sales, your BASIS cost IS NOT what you *actually* paid for the stock-- it's what you paid for the stock PLUS the "ordinary" income you reported for the discount. This means your Capital Gain on ESPP shares is smaller (or your Capital Loss larger) than what Fidelity reports on your year-end statement.

 ** WARNING **
Fidelity *does not* add this "ordinary income" to the basis cost, meaning that if you just blindly accept Fidelity's numbers for the Gain/Loss on the sale, you're getting double-taxed on the Compensation value: once as ORDINARY INCOME, and once as CAPITAL GAIN/LOSS.

To calculate the CAPITAL GAIN OR LOSS for DQDSP:

 1> Use the FAIR MARKET VALUE of the shares purchased (e.g. what you paid PLUS the $ discount) as your BASIS COST
 2> Calculate your GAIN or LOSS (PROCEEDS less BASIS)

To calculate the CAPITAL GAIN or LOSS for a QDSP:

 1> Determine how much ORDINARY INCOME you paid on the QDSP sale
 2> Add that value to your BASIS COST
 3> Calculate your GAIN or LOSS (PROCEEDS less BASIS)

At this point the record keeping is getting pretty hard, huh? Because you cannot trust the BASIS information reported to you (because it doesn't account for the "Compensation Value" treated as ORDINARY INCOME) you must understand which specific shares were sold as a part of each sale, so that you can properly compute the BASIS.

It gets worse.

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TAX LOTS
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When you go to sell stock, Fidelity shows a checkbox that allows you to choose "specific lots". This checkbox is unticked by default-- unless you tick it, Fidelity chooses which shares to sell (I'm pretty sure it sells FIFO by default). The problem is that your future reporting statements will not necessarily tell you WHICH tax lots were sold, and if you hold any shares throughout the year, the accounting gets quite hard.

For instance, say you buy 212 shares on March 31st, and sell 212 shares on April 5th. You might logically think that your April 5th sale represents the shares that you bought on March 31st. But if you didn't pick specific shares to sell, and already held any shares before March 31st, it's likely that some or all of those other, earlier shares are what actually sold. So, your order to sell 212 shares might actually be selling shares you bought last year, or whatever.

If you sold shares at a loss, it gets worse.

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WASH SALES
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Normally, if you sell shares at a loss, you get to claim a CAPITAL LOSS on your taxes (or shrink your CAPITAL GAINS). But there's a rule called the "Wash Sale Rule" which says that if you buy "substantially identical" stock within 30 days (before/after) of a losing sale, you don't get to directly claim the loss.

In the example above, you failed to specify the exact shares to sell in your April 5th sale. You're not selling the March 31st shares, and hence your March 31st ESPP purchase means that you've acquired "substantially identical" stock (http://www.fairmark.com/capgain/wash/wsreplac.htm). So if your sale of those older shares results in a loss, you don't get to claim that loss directly due to the Wash Sale rule.

Now, it's not the end of the world because the Wash Sale rule says that you get to use your loss to adjust the BASIS (price and date) of the new stock that you've acquired. But this means yet more accounting on your part.

But it gets worse.

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"IMPOSSIBLE" ACCOUNTING
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Fidelity will try to keep track of your wash sales and adjust the basis of your future sales accordingly. Unfortunately, that makes the record-keeping almost impossible. Firstly, adjusting the BASIS doesn't just change the basis price, it also changes the "effective" DATE of the purchase. So when you go to sell that March 31st stock, may get statements from Fidelity showing that you sold stock bought on "12/31/2009w" -- it's really your 3/31 stock but the basis has been adjusted due to your wash sale on April 5th. This can get extraordinarily confusing, because it means that neither the BASIS price nor purchase DATE for this set of shares corresponds to what was actually sold.

And that's a freakin' disaster, because as mentioned 3 sections ago, Fidelity fails to properly adjust the BASIS price of shares ESPP sales, meaning that you have to do it yourself. But since Fidelity has already "helpfully" changed the BASIS price and DATE to account for the WASH SALE, it can be virtually impossible to figure out WHICH shares were actually sold, meaning it's virtually impossible for you to properly adjust the BASIS to take into account the ORDINARY INCOME you recognized.

Oh, and keep in mind that the change of the BASIS DATE means that your later sale may be changed from a SHORT-TERM transaction to a LONG-TERM transaction. Confusing.
Oh, and keep in mind that because you often will be buying and selling different-sized blocks of shares, a given sale will likely be split up into multiple transactions, each tracking a different wash sale.

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CONCLUSIONS
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Now, the easy answer for all of this is to just give an accountant $300 bucks and a binder full of your documents and submit whatever tax return they prepare for you. But given the utter insanity of the math and the "lossy" record-keeping on Fidelity's statements and the W2, it's hard to imagine that a professional accountant would get this all done correctly either.

It's enough to make me wish for a flat tax even if I were to end up paying a lot more.

Thoughts for the future:

1> Always specify which tax lots to sell.
2> Always record myself what shares specifically were sold.

Even if I choose "wrong" and don't have the best tax outcome, at least I won't spend 9 hours trying to figure out which shares correspond to which transactions.