Tax returns get complex when you have various types of compensation income, such as from stock options, restricted stock, or an employee stock purchase plan (ESPP). For example, special reporting issues arise with restricted stock and restricted stock units (RSUs) that flummox even experienced accountants and financial advisors.
Mistakes can lead to overpayment of taxes or unwanted attention from IRS auditors.
Below are five reporting mistakes to avoid when you have compensation income from restricted stock/RSUs or sell shares acquired from these grants.
1. Not reporting income until the full grant vests. For restricted stock that vests over a number of years (e.g. 25% per year), you recognize and report income with each vesting slice, not in the year of grant or when the full grant is vested. One exception: If you made a Section 83(b) election (unavailable for RSUs), you elected to pay taxes on the full value of the restricted stock at grant and do not then report income again for the value of the shares at vesting.
2. Double-reporting income on Form 1040. You will mistakenly double-report income if you do not realize that your income in Box 1 of Form W-2 already includes stock compensation income (reported on Line 1 of Form 1040). Wrongly thinking that it was left off the W-2, or that the income your company voluntarily listed in Box 14 is separately reported on your tax return, may prompt you to erroneously report the income in the line for “Other income” (Line 21 on Schedule 1 of the revised Form 1040).
Alert: Doing this will cause the income to be taxed twice as ordinary income. You use Line 21 only when your company mistakenly omits the income received at vesting from your W-2.
3. Not reporting the stock sale. After selling the shares at vesting, since you have no additional proceeds from the grant beyond the income that’s reported on your W-2, you may erroneously believe you do not also need to report the stock sale. However, you still need to report this security sale on Form 8949 and Schedule D even though you are also including the income as part of your compensation income. For an annotated example of how to report the restricted stock sale on these tax forms, see the related FAQ at myStockOptions.com, an online resource devoted to all types of equity compensation.
Alert: If the IRS receives a report of your gross sale proceeds from your broker (on Form 1099-B) but without a corresponding report of the sale on your Form 8949, the IRS will conclude that you failed to report the gain on the sale. IRS computers are efficient at matching information on related tax forms. Using a tax basis of $0, the IRS computers will then automatically send you a notice (CP-2000) for the taxes due on the full amount of your sale proceeds.
4. Using too low a cost basis for the capital gains calculation. Even though you do not purchase stock acquired from restricted stock/RSUs, your tax basis for reporting the stock sale on Form 8949 is the amount of compensation income recognized at vesting that appeared on your Form W-2. If you made a Section 83(b) election, the basis amount is the value at grant on your Form W-2. For the cost basis, Box 1e of your Form 1099-B may be blank (or show $0) only because brokers are not allowed to report the cost basis for securities where no money is paid for them (technically called noncovered securities, e.g. restricted stock and RSUs).
Alert: Merely using what’s on the 1099-B, without this adjustment on Form 8949 to report the sale, will cause you to pay tax twice on the value of the shares at vesting.
5. Miscalculating the number of shares surrendered or sold for taxes. If you sold only some of the shares to pay the withholding taxes, you don’t want to report on your Form 8949 the cost basis for all the shares vested. That would result in a much larger tax basis and a capital loss for those shares sold. For a share surrender in which you receive only the net after-tax shares in your account, speak with your tax advisor about the need to report this type of withholding on Form 8949, as no stock sale occurred.
Alert: When you later sell the remaining shares in your grant, remember to exclude at that time from your reporting on Form 8949 the shares used earlier to fund the taxes (i.e. do not use the full number of vested shares). Otherwise you’ll report a cost basis for more shares than you sold.
For more guidance on tax returns that involve stock compensation, whether restricted stock/RSUs, stock options, ESPPs, or performance shares, see the Tax Center at myStockOptions.com.