Avoiding Double Taxation on RSUs, ESPP, ISOs, and Other Company Equity
Introduction
Traditionally, when stock is purchased and sold, you will receive a 1099 from your brokerage company for the year of security sale. This allows you to report the transactions to the IRS while filing your tax return. Employee equity transactions often require several adjustments when inputting the 1099 on one’s tax return. Missing these adjustments can result in severe overpayment of taxes.
Some brokerages provide the details in the backup pages on the 1099 form; other brokerages provide a 1099 supplemental. Both of these should provide the details necessary to make the appropriate adjustments to your 1099 entry on your tax return. Below, we will review some common types of employer equity and how one should avoid double taxation.
Restricted Stock Units (RSUs)
RSUs are a form of equity where you are granted stock that vests upon reaching criteria, typically time-based or performance-based. Once that criterion is met, the stock vests. Your company will include the total value of the stock as taxable income within your W2 based on the price on the vesting date. However, since you are taxed on the Fair Market Value (FMV) of the RSUs vesting, your cost basis becomes equal to the FMV. Going forward, your tax activity when you sell the position should be the difference between the RSU sale and the FMV at vesting. However, some 1099s report the transaction with a $0 cost basis. You will then need to adjust this by the amount in your W2 to ensure you are not doubly taxed.
Employee Stock Purchase Plan (ESPP)
ESPP is an equity plan that allows you to purchase company stock at a discount, typically 15% or 10%. Generally, your company will withhold a certain percentage of your post-tax salary in an escrow account for six months before purchasing it on the vesting date. Until your stock is sold, no taxable event will be created. However, once you sell the stock, your company will report the discount* you receive on your W2 as ordinary income. Unfortunately, your 1099 will include the discounted price as the original cost basis. This can be problematic because you already pay taxes on the discount; therefore, your cost basis should be adjusted up accordingly.
* The ordinary income reported will depend on how long you held your ESPP stock after vesting. If you held it for at least two years since the grant date of your ESPP and one year since vesting, you will receive qualified disposition treatment, where the ordinary income is capped at the discount percentage multiplied by the the original grant price. If you held it for less, you would receive disqualified disposition treatment, where the ordinary income is the fair market value at the vesting date subtracted by the discounted purchase price.
Incentive Stock Options (ISOs)
ISOs are a form of equity where an employee is granted the option to purchase company stock at a specific exercise price. Earlier-stage companies typically grant these and have the potential to substantially increase in value or become worthless. There are no taxable events when your options vest and become exercisable. When you exercise the options and/or sell the subsequent stocks, your company may report taxable income on your W2, depending on whether it was a disqualifying disposition or a qualifying disposition. However, when ISOs are exercised and not sold in the same calendar year, you may trigger the Alternative Minimum Tax (AMT) based on the bargain element; the fair market value at the time of exercise is subtracted by the exercise price. If AMT is paid, you may recover it in future tax years if your Alternative Minimum Taxable Income (AMTI) is lower than your regular tax liability.
Once the stock is sold, you will not need to adjust the cost basis on your regular Schedule D. However, the AMT system is a secondary tax system that runs parallel to normal tax filing. If the stock sold was exercised in a different calendar year, it is likely you should adjust the cost basis on the AMT Schedule D since this will decrease your AMTI, thus allowing you to reclaim more of your AMT credit.
Our Review
The various situations around cost basis adjustments on one’s tax return can be complex, and the scenarios above are the most common adjustments we see with employer equity. Our services at Astra Wealth Partners include reviewing your tax return for these potential double taxation mistakes, as well as coordinating with your accountant to ensure they have the correct cost basis adjustments needed to file and or amend your tax returns correctly.
If you have any questions or are interested in becoming a client with Astra Wealth Partners, schedule a meeting with us below!
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