Is it possible you paid tax twice on your equity compensation and did not know it? If your CPA was calculating your tax liability only off of the 1099-B provided by the brokerage firm administering your equity compensation plan, the answer is yes.
The potential for tax traps was created when the IRS revised Regulations 1.6045-1. It requires brokers to list the initial basis (exercise price) on Form 1099-B for income recognized upon the exercise of equity-based options or the vesting or exercise of other equity-based compensation arrangements, granted or acquired after 2013. How they report Pre-2014 grants vary per custodian, and we have even found some inconsistencies within the same custodians.
Equity Compensation Over-Reporting of Income
|NSO or ISO
Reported on W2
Reported on W2
|Equity Award Shares||20,000||20,000||20,000|
|FMV on date of exercise or vest||$54.00||$1,080,000||$1,080,000|
|Equity Award Acquisition Price||$24.00||$480,000||$0|
|Reported basis on brokerage 1099-B||$24.00||$480,000||$0|
|Actual basis to correct on Form 8949||$54.00||$1,080,000||$1,080,000|
|Over Reporting of Income||$600,000||$1,080,000|
*chart is for example purposes only. Non-statutory Stock Options (NSO), Incentive Stock Options (ISO), Restricted Share Units (RSU), Restricted Share Awards (RSA), Performance Share Units (PSU), Performance Share Awards (PSA)
This creates two possible traps.
The first trap is in the year of exercise. This one is less likely to happen due to the exercise and sale happening in the same year. The executive’s CPA will often pick up the extra income on the W2 detail showing the equity compensation and be able to match the income shown on the 1099-B that will be the same or close to the extra W2 income. CPAs could have you pay tax twice in the event they don’t have or match up your payroll detail or notice that the acquisition date and disposition date are the same. The executive will be paying short-term capital gains that are equal to the option income.
The second and more likely trap is when the executive sells the shares acquired through the equity-based compensation years later. The brokerage firm is required to report the basis of the sale as the exercise price vs. the true basis of the fair market value at the time of exercise. For most executives, this means they could pay long-term capital gains on gains they may not actually owe. Any stock they acquired after 2013 will likely be the incorrect basis reported by the brokerage firm. Although reporting the basis was discretionary prior to 2014, when the pre-2014 basis is shown, it is most often the correct fair market value at exercise.
Due to the potential significance of this reporting and tracking issue, an executive and/or his advisors need to be tracking this double basis from equity compensation until all the shares acquired with this incorrect basis have been sold and corrected through their tax filings during their lifetime. SignatureFD is always available to answer any questions related to this topic.
Click here for full post and examples of how this should be reported and corrected on a tax return.