Could you have paid tax twice on your equity compensation and did not know it? If your CPA was calculating your tax liability off of the 1099-B provided by the brokerage firm administering your equity compensation plan, the answer is yes.
When the IRS revised Regulations 1.6045-1, it created the potential for tax traps. Regulations 1.6045-1 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 varies 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 can have you pay tax twice if they don’t have or match up your payroll details or notice that the acquisition date and disposition date are the same. The executive will be paying short-term capital gains 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 will 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 are paying long-term capital gains on gains they don’t actually owe. Any stock they acquired after 2013 will be on the incorrect basis reported by the brokerage firm. Although discretionary, the basis was shown at the fair market value of exercise before 2014.
In the below Form 1099-B, note the January 16, 2018 transaction. It erroneously shows a gain of $600,000 when there is no gain. The true basis is $1,080,000 vs. the $480,000 shown. If someone completes their own taxes and plugs data into tax software, or the CPA does not pay attention to the dates, it will overstate their taxable income by $600,000.
Below are brokerage statements that reflect the potential of the more likely trap where the executive or their CPA prepares their taxes based on the information provided by their brokerage firm. The brokerage firm will report the basis of the sale as the exercise price vs. the true basis of the fair market value at the time of exercise. The statement is over-reporting capital gains by $981,929.
Executives Actual Brokerage Statement with Required Reporting
The Executive’s True Cost Basis
If you or your advisor are keeping track of your true basis, how do you correct it?
Brokerage firms cannot change the reported basis, and even if you transfer shares to a new brokerage firm, the basis received from the old brokerage firm can’t be changed, except for the death of the owner. It is up to you or your CPA to correct the basis using Form 8949.
In the intricate realm of equity compensation and taxation, the possibility of paying taxes twice on gains may be a harsh reality for those relying solely on the 1099-B provided by their brokerage firm. The revised IRS Regulations, particularly 1.6045-1, created potential pitfalls, notably in reporting the basis for equity-based options. Addressing this issue requires vigilance from individuals or their CPAs, who must navigate the complexities of Form 8949 to rectify these discrepancies.
Are you concerned you may have fallen into the double tax trap? Contact Dan Dubay, director of SignatureExecutive, today.
SignatureFD is a financial advising firm headquartered in Atlanta, Georgia. We believe in helping our clients achieve wealth beyond money. Our team of investment, financial planning and tax experts are committed to proactively helping clients take control of their financial lives and achieve their goals.
Dan Dubay, CFP®, is a partner, wealth advisor and director of SignatureExec. Dubay has served as president of the Financial Planning Association of Georgia, is a member of the Georgia Planned Giving Council and has served as a content expert for the Certified Financial Planner Board of Examiners.