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12 Tax Return Mistakes To Avoid With Your Stock & ESPP’s

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12 Tax Return Mistakes to Avoid With Your Stock & ESPPsHere we will review the most common mistakes and errors that you need to avoid when filing your income tax return after the sales of shares received through stock compensation. This article is based on content from the Tax Center on myStockOptions.com, a respected independent source of content and tools on all types of equity compensation.

Let’s get right to the mistakes you need to avoid and prevent you from incorrectly paying your income taxes for 2016:

 

Non-qualified Stock Options (NQSO’s)

Mistake #1: Double-Counting Option Income

When you exercise NQSOs, even if you don’t sell any shares, the difference between the exercise price and the fair market value of the shares will be treated as ordinary income and included in Box 1 of your Form W-2. For incentive stock options (ISO’s), only when you make a disqualifying disposition will the income appear on your W-2, but withholding taxes will not be made.

Planning Point: Some companies report NQSO income in Box 12 of Form W-2, using Code V (this is not used for ISOs, restricted stock/RSUs, or tax-qualified ESPPs). On your Form 1040, Line 21, Other Income, do NOT make the mistake of listing the amount shown in Box 12 of your W-2 or any income already included in Box 1 for stock compensation here. It is already included as part of Line 7 of the Form 1040 (wages, salaries, tips). That would be very expensive double counting of your income!

Mistake #2: Failing To Report Sales

If you exercised NQSOs during 2016, the withheld federal, state, Social Security, and Medicare taxes will appear on your Form W-2, along with the spread at exercise, taxed as ordinary income. If you sold shares during 2016, your broker should send you a 1099-B reporting the sales, which you must report on Form 8949. You will have no withholding upon ISO exercise or a purchase in a tax-qualified ESPP.

Mistake #3: Miscalculating the Cost Basis

When you sell your shares, the sales price (less commissions) less your cost basis equals your capital gain or loss.

The revised 1099-B now reports your tax basis in Box 1e. However, the cost-basis information reported to the IRS in Box 1e of Form 1099-B may be too low or the box may be blank. This is because the rules for cost-basis reporting are mandatory only for stock acquired in 2011 and later. Brokers can include only the compensation part of the basis for sales of shares acquired from grants made before 2014. As explained by the experts at myStockOptions.com, more confusion can occur since shares not acquired for cash, such as shares from a stock-swap exercise, SARs exercise, or restricted stock vesting, are considered ‘non-covered securities’.

Mistake #4: Capital Gains Tax Rate

To determine whether you are entitled to long-term capital gains treatment on the sale of your shares, do not include the time you held your options. Your holding period begins only once you exercise your stock options. When you report the stock sale on Schedule D, do not make the exercise price your cost basis. Avoid double taxation by listing the market price on the exercise date as your stock’s cost basis, which is the exercise price plus the amount of ordinary income you as reported on your W-2 and paid taxes on.

Mistake #5: Sale of Stock Acquired from NQSO Exercise

Confusion often occurs when NQSOs are exercised with a simultaneous sale of the stock in a cashless exercise. After you receive Form 1099-B reporting the sale, you must report the proceeds on the appropriate line of Form 8949 although the amount of gain or loss you report may be $0 or minimal. Since the exercise spread is already reported as compensation in your Form W-2, the stock’s cost basis will be equal or very close to the value of the stock on the date of exercise. Be sure you don’t erroneously exclude this W-2 income by reporting the wrong basis on Form 8949, a common mistake.

Planning Point: The exercise spread is reported on your W-2 and on your tax return as ordinary income. Although you never owned the stock after exercise, you still need to report this transaction on Schedule D of your 1040 even if you have no gain and are also including it as part of your compensation income.

Mistake #6: Grant of NQSOs NOT Taxable

If you received a grant of NQSOs from your company and did not exercise the options, generally you are not subject to tax and you don’t need to report the grant on your tax return. Even if a stock option grant vested and became exercisable for the first time last year, you still have no tax or filing requirements if you did not exercise the stock options.

Restricted Stock

Mistake #7: Reporting Too Many Shares Sold

Upon receiving restricted stock your company may require you to surrender shares to meet withholding tax. If you later sell the remaining shares you must remember to exclude the shares you used to meet your requirements for withholding taxes on form 8949 of your tax return. Otherwise, you will report on your Schedule D more shares than you actually sold.

Mistake #8: Reporting Your Cost Basis as Zero

When your restricted stock vests, to avoid having your income taxed twice you must report the cost basis on Form 8949. Often taxpayers incorrectly report their restricted stock’s cost basis as $0, since they did not pay for it. Do not assume that, because you did not pay any money to purchase the stock or exercise anything, your tax basis is zero. The cost basis is the amount of income included on your W-2. If you sell the restricted shares, the sales price less your cost basis will equal your capital gain or loss and would be reported on Schedule D.

Mistake #9: Waiting until the Entire Grant Has Vested

For restricted stock that vests incrementally over a number of years (e.g. 25% per year), you realize and report for each year the W-2 income from the percentage of stock that vested during the year. You do not wait until the whole grant has vested—unless, of course, the grant vests all at once.

Planning Point: If you made a Section 83(b) election (not available for RSUs or performance shares) to pay tax on the full value of the restricted stock at the date of grant, you must report the restricted stock value in the tax year and thus you do not later report the income from the value of the shares at vesting.

Mistake #10: Counting Dividend Income Twice

Dividends received on restricted stock can raise a few tax-reporting issues during vesting and after the shares vest. The dividends will be regular compensation during vesting and taxable as qualified dividends. Be sure not to duplicate dividend income that is part of your W-2 in the total received dividends on your Form 1040.

Employee Stock Purchase Plans (ESPP’s)

Mistake #11: Understand 1099-B

For 2016 sales of company stock acquired from equity compensation and ESPPs, brokers can either (1) report the complete cost basis for pre-2014 grants, while reporting only the partial basis for later grants, or (2) report the unadjusted partial basis for all grants. If this is not clearly explained, be sure to ask your company and its stock plan service provider if any compensation income was included in your cost basis.

Mistake #12: Make an Appropriate Adjustment on Tax Form

You can make an adjustment in your gain or loss from the sale of stock from your ESPP on Form 8949 and Schedule D if the compensation part of the cost basis is not included on Form 1099-B.  Form 8949 and Schedule D have a column you can use for this adjustment. You simply report the basis given on the Form 1099-B and adjust it indirectly on the column.

For guidance on the tax-return reporting for sales of shares acquired through stock compensation, including annotated, illustrated diagrams of Form 8949 and Schedule D, see the section Reporting Company Stock Sales in the myStockOptions.com Tax Center. Elsewhere in the Tax Center, another section gathers annotated diagrams of Form W-2. These can help you make sense of Form W-2 (which companies issue in January) when the reporting on the form includes income you received from stock options, restricted stock/RSUs, or employee stock purchase plans.

This is a guest contribution James J. Di Gesu, CPA, PFS, MBA. James is the Sr. Vice President of Wealth Health LLC

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