“March Madness” could be a name not only for the NCAA basketball tournament but also for the annual tax-return season, which hits full swing this month. If you’re one of the millions of employees in the United States with nonqualified stock options or restricted stock units, or if you participate in an employee stock purchase plan (ESPP), income from your equity awards last year will complicate your tax return.

Nobody likes doing homework for the IRS, but the handy “cheat sheet” in this article below can make the assignment easier for tax returns involving equity compensation and company stock sales. Even if you hire a professional preparer to handle your tax return, such as a CPA or enrolled agent, check your return for these items. You don’t want to overpay taxes or draw unwanted IRS attention that leads to a scary notice or audit.

Compensation Income

Stock compensation, along with your salary income, is included in what is reported in Box 1 of your Form W-2. You enter the amount in Box 1 on Line 1a of Form 1040.

Alert: Be sure you don’t double-report any stock compensation income that also appears in Box 12 or 14 of your W-2 (or on a paystub).

Capital Gain Or Loss

If you sold shares during the prior tax year—even shares sold immediately at exercise, vesting, or purchase for no additional gain beyond what’s on your W-2—you still separately report each sale. You then report that Schedule D capital gain/loss total on Line 7 of Form 1040.

Alert: Should you not report the sale, the IRS will almost certainly send you a notice demanding taxes on the full amount of your unreported sale proceeds. That would require you to potentially amend your tax return or engage in ongoing communications with the IRS to explain the situation. Not fun.

Check The Cost-Basis Reporting For Company Stock Sales

Here comes the really tricky part: adjusting the cost basis (or tax basis) of equity awards, i.e. the full cost of shares that generated compensation income. The cost basis is subtracted from your proceeds to calculate your gain or loss for tax purposes.

For shares bought in the open stock market, your cost basis is the purchase price. With equity compensation, the basis calculation includes the cost plus any compensation income recognized—for example, the exercise spread of nonqualified stock options (NQSOs) or the value of the shares at the vesting of restricted stock units (RSUs).

Form 1099-B reports your basis in Box 1e. Instead of boxes, your broker’s substitute statement will use columns numbered the same as the boxes on Form 1099-B. The same numbering is used on Form 8949.

However, the cost-basis information reported to the IRS by your broker in Box/Column 1e of Form 1099-B may be too low, or the box may be blank. IRS rules do not allow your broker to include the compensation income in the basis that’s reported on the 1099-B.

Alert: If the basis listed on the 1099-B is your option exercise price or your ESPP purchase price (or simply $0), then it is likely to be incomplete. You are at risk for overpaying your taxes. An adjustment will be needed on IRS Form 8949, which is used to report the sale, and its totals then funnel into Schedule D. For insights on what to do, see tip #2 in my Forbes.com article Pro Tips: 4 Tax Return Errors To Avoid With Stock Options, RSUs, And Stock Sales.

Alternative Minimum Tax (AMT)

For a few years now, the alternative minimum tax (AMT) has not had its own line on the main Form 1040—but that doesn’t mean it’s gone away! The AMT remains a concern for everyone with incentive stock options (ISOs). It is calculated on Form 6251:

  • Exercise year: The spread at ISO exercise is reported on Line 2i if the stock was not sold during the calendar year of exercise.
  • Sale year: After you sell ISO stock that triggered the AMT, the difference from the ordinary income tax is reported on Line 2k.

If your AMT is higher than your regular tax, you report this additional amount from your Form 6251 calculation on Line 1 of IRS Schedule 2 (“Additional Taxes”). The totals from Part I of Schedule 2 go into Line 17 on Form 1040.

After you trigger the AMT from an ISO exercise, you get an AMT credit that you can apply in every subsequent year when your ordinary income tax exceeds your AMT. You use Form 8801 to calculate how much of the credit you can apply each year. You carry forward the rest.

Alert: You do not need to sell the ISO stock to start using up the AMT credit. You continue to complete Form 6251 and 8801 each year until the credit is used up.

Equity Compensation Income Left Off W-2

What if your company does not report your employee stock compensation income on Form W-2? According to recent changes to Schedule 1 of Form 1040 and its instructions, the amount goes in the “Other Income” section on Line 8k (“Stock Options”).

If you are not certain that all equity compensation left off the W-2 goes on Line 8k, then it can fit into Line 8z (“Other Income. List type and amount”).

Estimated Taxes

The flat 22% rate often used for federal supplemental withholding on employee stock compensation may not cover the actual taxes you owe, given your marginal tax rate. You may have decided to pay estimated taxes to cover the additional taxes owed. On Form 1040, you report estimated tax payments on Line 26.

IRS Form 1099-NEC For Nonemployees

Nonemployees, such as consultants and directors, have no withholding and no W-2 reporting for stock comp income. Income from exercise or vesting appears on IRS Form 1099-NEC (“Nonemployee Compensation”) as self-employment income. This is shown in Boxes 1 and 7 of Form 1099-NEC. You report that income on Schedule C of your Form 1040 tax return.

As this is self-employment income, you also need to calculate on Schedule SE any Social Security and Medicare taxes that you owe.

Further Resources

The Tax Center at the website myStockOptions.com has resources devoted to tax returns involving equity compensation, including annotated diagrams of Form W-2, Form 3921, Form 3922, and Form 1099-NEC. For stock sales, annotated diagrams of Form 8949 and Schedule D show you how to report sales to adjust for an incomplete cost basis.

Read the full article here

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