The IRS has overhauled the Form 1040 tax return. The changes affect the reporting of income from equity compensation and stock sales.

Stock Options

  1. With a cashless exercise/same-day sale, the spread is reported on your W-2 and on your tax return as ordinary income. Even though you never owned the stock after exercise, you still need to report this transaction on Form 8949 and Schedule D, which are used to report capital gains and losses on all stock sales. You may even have some small gains or losses, depending on how your company calculates the spread at exercise and on any commissions and fees for the stock sale.

    Alert: If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but not a corresponding report of the sale on your Form 8949 and Schedule D, it would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.

  2. With nonqualified stock options (NQSOs), for employees the spread at exercise is reported to the IRS on Form W-2 (for nonemployees, it is reported on Form 1099-MISC). It is included in your income for the year of exercise. (Income from an ISO disqualifying disposition, such as an early sale, will also appear.) Thus, when you report the sale on Form 8949, Box 1e on your 1099-B will probably report the exercise price as the cost basis. Do not list the exercise price as your cost basis without also making an adjustment in column (g). Only for ISO stock sold in a qualifying disposition will the tax basis equal the exercise price.

    Alert: If the cost basis is not reported on Form 1099-B, avoid double taxation by listing the market price on the date of exercise as your cost basis in the stock. The basis should be the exercise price plus the amount of ordinary income you already paid taxes on.

  3. You will also mistakenly double-report income if you do not realize that your W-2 income in Box 1 already includes stock compensation income. Wrongly thinking it was left out may prompt you to erroneously report the income as “Other income” on Schedule 1 (Line 21). Doing that would cause the income to be taxed twice as ordinary income, as it was already included in the W-2 income reported on Line 1 of Form 1040. You use Line 21 of Schedule 1 only if your company mistakenly omits the income from your W-2 or 1099-MISC.

    Each type of exercise method can create its own confusion with the reporting of shares sold either at exercise or later. For example, if you sold only some of the shares in a sell-to-cover exercise, you don’t want to report on your Form 8949 the cost basis for all the shares exercised. This would result in a much larger tax basis and a capital loss for these shares sold.

  4. With incentive stock options (ISOs), when you exercise and hold through the calendar year of exercise, remember that you need to complete an alternative minimum tax (AMT) return (Form 6251) to see whether you owe AMT. If the tax amount is higher than the ordinary income tax, you need to pay AMT. Your company does not send you a W-2 for this spread amount when you hold the ISO stock, so remember to do this. For more details on the AMT, see the content sections AMT and AMT Advanced.

    Alert: ISO exercises in a given tax year are reported on IRS Form 3921 early in the following year. The form helps you collect information for reporting sales of ISO shares on your tax return. It also helps in the AMT calculation at exercise. The IRS receives a copy of the form, ensuring that it knows about your ISO exercise and therefore any AMT triggered by the exercise income.

  5. When you have paid AMT because of your ISO exercise and hold, you get a tax credit. The rules now get even more complex. You do not need to sell the stock to start using this credit. In addition, every year until the credit is used up, you do need to complete IRS Form 8801 to calculate it. Once you have sold the stock, avoid paying or calculating more AMT than is required for your ISO stock sale by reporting (as a negative amount) your “adjusted gain or loss” on Part I of IRS Form 6251.

  6. When you report sales on Form 8949, always use the gross proceeds amount/number on the Form 1099-B you get from your broker. This is what the IRS receives. On Form 1099-B, your broker is now required to subtract commissions or other fees, but if it does not, remember to instead make an adjustment in column (g) of Form 8949. Do not add commissions or fees to the cost basis.

  7. Proceeds from stock held for more than 12 months after exercise and then sold qualify for the long-term capital gains rate (15% or 20%, depending on yearly income). Although qualifying dividends are subject to the same tax-bracket thresholds and rates as capital gains, you do not report dividends with capital gains, and you cannot net them out.

  8. Can’t meet the deadline? File an extension. If you cannot meet the deadline of April 15, 2019, for 2018 federal tax returns, you should file an extension of the deadline with the IRS. Understand, however, that this delays only the deadline for filing your tax return, not the payment of any tax due. You must still pay any owed taxes by the deadline, and to do this you must accurately estimate the amount. By paying at least 90% of your tax when you file the extension, you avoid a penalty for late payment of tax. Also, don’t forget about your state tax return.

Employee Stock Purchase Plan

Below are some common mishaps with employee stock purchase plans (ESPPs). Understanding these will help you prevent overpaying your taxes or incurring complications with the IRS for underpaying.

Purchases in a tax-qualified ESPP are reported on IRS Form 3922. The form, which your company should issue before the end of the January after the year of purchase, helps you collect information for reporting sales of the shares on your tax return. The forms also give the IRS information about your transactions.

  1. Not filing Form 8949 after an immediate sale of ESPP shares at purchase. With an immediate sale of your ESPP shares at purchase, the discount is reported on your W-2 and on your tax return as ordinary income. Even though you never held the stock (or at least not for long) after purchase, you still need to report this sale transaction on Form 8949 and Schedule D, which are used to report capital gains and losses on all stock sales. You may even have some small gains or losses, depending on how your company calculates the discount at purchase, how long it takes for the shares to become available in your account, and any commissions and fees for the stock sale.

    Alert: Even if you sold all of your ESPP stock immediately at purchase and all of the resulting income is on your W-2, you still must report the sale on Form 8949 and Schedule D. If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but not a corresponding report of the sale on your Form 8949, it would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.

  2. Paying tax on the discount too early. Depending on the design of your company’s ESPP, Section 423 of the Internal Revenue Code lets you buy company shares through after-tax payroll deductions at a discount of up to 15% off the fair market value of your company’s stock. You should not include the discount as part of your taxable income for the year of purchase unless you also sold the shares in the same year. When you don’t satisfy the ESPP holding periods, you have compensation income in the year of sale equal to the spread at purchase, i.e., the difference between the fair market value of the stock on the purchase date and the discounted price you actually paid for it.

    For sales of shares acquired from ESPPs that are not tax-qualified under IRC Section 423, the taxation, along with the potential reporting mistakes, is similar to that for NQSOs. The income would be reported, and would appear on your W-2, in the year of purchase, regardless of whether you sell the stock.

  3. Directly using what appears as the cost basis on your Form 1099-B. The expanded Form 1099-B cannot report the compensation element as part of your cost basis, as only the purchase price will appear, and the basis does not need to be included for stock that was purchased before 2011. This means you must check the accuracy of the basis and make any necessary adjustments on Form 8949.

    Alert: When compensation income is not part of the tax basis reported in Box 1e on Form 1099-B, make an adjustment in column (g) of Form 8949, among other steps. Should Box 1e be blank, report the full basis in column (e).

  4. Paying the wrong tax on the discount. The discount doesn’t qualify for capital gains treatment even when you have held your stock for longer than one year. If you hold the shares for more than one year after the date of purchase, and more than two years after the beginning of the offering period, with a tax-qualified (Section 423) ESPP you’ll have ordinary income in the year of sale equal to the lesser of either the actual gain upon sale or the purchase price discount at the beginning of the offering. But beyond the discount, all additional gain is treated as long-term capital gain. However, with a decreasing stock price, when you sell the shares at a loss you have no ordinary income, just a capital loss. Only in that situation, with all capital loss, will the cost basis on Form 1099-B be correct and not need an adjustment.

  5. Using the wrong price when there is no lookback. If your company eliminated the lookback for your ESPP, the actual discount for the purchase and for tax purposes will often differ with a qualifying disposition, adding to the potential for tax-return mistakes. Even with an ESPP that has no lookback, the purchase price discount for the taxes is still computed from the price on the first day of the offering period and not on the purchase date.

  6. Paying tax twice on the discount. With ESPPs, the purchase discount is reported to the IRS on Form W-2 and is included in your income in the year of sale. Thus, when you sell the shares, do not make the purchase price your cost basis when you complete Form 8949 to report the sale. Avoid double taxation on the discount by understanding what the cost basis on your 1099-B includes and why it may be wrong (see #3 above).

    You will also mistakenly double-report income if you do not realize that your W-2 income in Box 1 already includes stock compensation income. You may wrongly think it was left out because there is no tax withholding or employment tax (i.e., Social Security and Medicare) on a tax-qualified ESPP, and then erroneously report the income as “Other income” on Schedule 1 (Line 21). Doing that would cause the income to be taxed twice as ordinary income, as it was already included in the W-2 income reported on Line 1 of Form 1040. You use Line 21 of Schedule 1 only if your company mistakenly omits the income from your W-2.

  7. Not considering the brokerage commission. When you report sales on Form 8949, always use the gross proceeds amount/number on the Form 1099-B you get from your broker. This is what the IRS receives. If the form does not subtract commissions or other fees, remember to instead make an adjustment in column (g) of Form 8949.

  8. Proceeds from stock held for more than 12 months after purchase and then sold qualify for the long-term capital gains rate (15% or 20%, depending on yearly income), even if the shares were sold less than 24 months from enrollment in a disqualifying disposition. Although qualifying dividends are subject to the same tax-bracket thresholds and rates as capital gains, you do not report dividends with capital gains, and you cannot net them out.

  9. Can’t meet the deadline? File an extension. If you cannot meet the deadline of April 15, 2019, for 2018 federal tax returns, you should file an extension of the deadline with the IRS. Understand, however, that this delays only the deadline for filing your tax return, not the payment of any tax due. You must still pay any owed taxes by the deadline, and to do this you must accurately estimate the amount. By paying at least 90% of your tax when you file the extension, you avoid a penalty for late payment of tax. Also, don’t forget about your state tax return.

Stock Appreciation Rights

  1. With a cashless exercise/same-day sale, the spread is reported on your W-2 and on your tax return as ordinary income. Even though you never owned the stock after exercise, you still need to report this transaction on IRS Form 8949 and Schedule D, which are used to report capital gains and losses on all stock sales. You may even have some small gains or losses, depending on how your company calculates the spread at exercise and on any commissions and fees for the stock sale.

    Alert: If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but not a corresponding report of the sale on your Form 8949, it would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.

  2. For employees who exercised stock appreciation rights (SARs), the spread at exercise is reported to the IRS on Form W-2 (for nonemployees, it is reported on Form 1099-MISC). The exercise spread is included in your income for the year of exercise. When you report the sale of the shares acquired in the SARs exercise on Form 8949, you avoid double taxation on the spread by checking to see whether it is part of the cost basis or whether an adjustment is needed on the form. You are taxed on the capital gain or loss as calculated by the difference between the net sales price and your tax basis per share (i.e., the total spread at exercise divided by the number of shares received for the spread, which equals the stock price at exercise). While the expanded Form 1099-B may not report any basis for SARs stock in Box 1e (because some brokerage firms view SARs as a noncovered security) you still must report the full basis on Form 8949.

    Example: You exercised 2,000 SARs when the market price was $50 per share and the grant price was $20 per share. This resulted in 1,200 shares [($50 – $20) x 2,000 = $60,000 spread; this amount is divided by the $50 stock price to give 1,200 shares]. More than one year later, you sold the 1,200 shares at $60 per share, minus commissions and fees of $500 ($71,500 net sales proceeds on Form 1099-B). Your W-2 shows $60,000 of income from the exercise. Your tax basis is $60,000 for column (e) of Form 8949, and column (h) reports the $11,500 gain. Part II of your Schedule D includes this long-term capital gain of $11,500.

  3. You will also mistakenly double-report income if you do not realize that your W-2 income in Box 1 already includes stock compensation income. Wrongly thinking it was left out may prompt you to erroneously report the income as “Other income” on Schedule 1 (Line 21). Doing that would cause the income to be taxed twice as ordinary income, as it was already included in the W-2 income reported on Line 1 of Form 1040. You use Line 21 of Schedule 1 only if your company mistakenly omits the income from your W-2 or 1099-MISC.

  4. If you surrendered or sold shares at exercise to pay the withholding tax, you want to report any actual market sale of shares on your Form 8949. (For share surrender, speak with your own tax advisor about the need to report this.) Then, when you later sell the remaining shares in your grant, remember to exclude from your Form 8949 at that time the shares used earlier to withhold taxes (i.e., do not use the full number of granted shares or the full number of shares that were part of your W-2 income at exercise). Otherwise you’ll report more shares than you actually sold.

  5. When you report sales on Form 8949, always use the gross proceeds amount/number on the Form 1099-B you get from your broker. This is what the IRS receives. On Form 1099-B, your broker is now required to subtract commissions or other fees, but if it does not, remember to instead make an adjustment in column (g) of Form 8949. Do not add commissions or fees to the cost basis.

  6. Proceeds from stock held for more than 12 months after exercise and then sold qualify for the long-term capital gains rate (15% or 20%, depending on yearly income). Although qualifying dividends are subject to the same tax-bracket thresholds and rates as capital gains, you do not report dividends with capital gains, and you cannot net them out.

  7. Understand the reporting for a cash-settled SAR. If you have a cash-settled SAR and no Form 1099-B is issued, then you do not have a security sale to report on Form 8949. You have just the W-2 income (i.e., the cash received from the spread at exercise).

  8. Can’t meet the deadline? File an extension. If you cannot meet the deadline of April 15, 2019, for 2018 federal tax returns, you should file an extension of the deadline with the IRS. Understand, however, that this delays only the deadline for filing your tax return, not the payment of any tax due. You must still pay any owed taxes by the deadline, and to do this you must accurately estimate the amount. By paying at least 90% of your tax when you file the extension, you avoid a penalty for late payment of tax. Also, don’t forget about your state tax return.

Restricted Stock Units

W-2 and Ordinary Income Reporting

When restricted stock vests or restricted stock unit (RSU) shares are delivered, the full value of the shares at vesting is reported on your Form W-2. If you are a nonemployee, such as a director, this income appears on Form 1099-MISC. Employees include this value on tax returns as part of salary/compensation income on Line 1 of Form 1040. It’s the same for restricted stock units, as long as all the shares are delivered at vesting.

For restricted stock that vests over a number of years (e.g., 25% per year), you realize and report W-2 income with each vesting slice, not when the full grant is vested.

Dividend Reporting

Dividends you receive on restricted stock can raise a few tax-reporting issues during vesting and after the shares vest. In short, the dividends paid will be compensation during vesting (unless you made a Section 83(b) election, which makes the dividends eligible for the lower tax rate on qualified dividends). Be careful not to duplicate dividend income that is part of your W-2 in the total received dividends on your Form 1040.

Biggest Mistakes

Most of the other potential mishaps, presented below, concern reporting stock sales on IRS Form 8949 and Schedule D of IRS Form 1040.

  1. After selling any or all of the shares at vesting, you still need to report this sale on Form 8949 and Schedule D even though you have no “gain” beyond what is part of your compensation income. You may, however, have a small gain or loss, depending on how your company calculates the stock value at vesting and any commissions and fees for the stock sale.

    Alert: If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but not a corresponding report of the sale on your Form 8949, the IRS would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due on the full amount of the proceeds.

  2. Your cost basis for reporting the stock sale in column (e) on Form 8949 is the amount of compensation income at vesting that appeared on your W-2 (you already reported it on your tax return), even though you never purchased the stock. If you made a Section 83(b) election (not available for RSUs), the basis amount is the value at grant on your W-2. Do not assume that, because you did not pay any money to purchase the stock or exercise anything, your tax basis is zero. Otherwise, you will pay double tax on the value of the shares at vesting. For the cost basis, Box 1e of your 1099-B may be blank (or show $0) only because brokers are not required to report the cost basis for noncovered securities, such as restricted stock and RSUs (some brokers may report the basis on the 1099-B that you receive, but not on what they report to the IRS).

  3. You will also mistakenly double-report income if you do not realize that your W-2 income in Box 1, reported on Line 1 of Form 1040, already includes stock compensation income. Wrongly thinking it was left out may prompt you to erroneously report the income as “Other income” on Schedule 1 (Line 21). Doing that would cause the income to be taxed twice as ordinary income, as it was already included in the W-2 income reported on Line 1 of Form 1040. You use Line 21 of Schedule 1 only if your company mistakenly omits the income from your W-2 or 1099-MISC.

  4. If you surrendered or sold shares at vesting to pay the withholding tax, you want to report any actual market sale of shares on your Form 8949. For a share surrender in which you receive only the net after-tax shares in your account, speak with your own tax advisor about the need to report this. Alternatively, if you sold only some of the shares (e.g., for taxes), you don’t want to report on your Form 8949 the cost basis for all the shares vested. This would result in a much larger tax basis and a capital loss for these shares sold.

    Alert: When you later sell the remaining shares in your grant, remember to exclude from your Form 8949 at that time the shares used earlier to withhold taxes (i.e., do not use the full number of granted shares).

  5. When you report sales on Form 8949, always use the gross proceeds amount/number on the Form 1099-B you get from your broker. This is what the IRS receives. On Form 1099-B, your broker is now required to subtract commissions or other fees, but if it does not, remember to instead make an adjustment in column (g) of Form 8949. Do not add commissions or fees to the cost basis.

  6. Your capital gains holding period begins at vesting, not at grant (the opposite is true when you make a Section 83(b) election). Proceeds from stock held for more than 12 months after vesting and then sold qualify for the long-term capital gains rate (15% or 20%, depending on yearly income). Although qualifying dividends are subject to the same tax-bracket thresholds and rates as capital gains, you do not report dividends with capital gains, and you cannot net them out.

  7. Can’t meet the deadline? File an extension. If you cannot meet the deadline of April 15, 2019, for 2018 federal tax returns, you should file an extension of the deadline with the IRS. Understand, however, that this delays only the deadline for filing your tax return, not the payment of any tax due. You must still pay any owed taxes by the deadline, and to do this you must accurately estimate the amount. By paying at least 90% of your tax when you file the extension, you avoid a penalty for late payment of tax. Also, don’t forget about your state tax return.