Tax Alert: Beware of “double taxation” on employee stock options

While Tax Day has passed, the time to pay close attention to your tax return never does.  You can always file an amendment and if you filed an extension you have until October 31st to make any changes.

We want to bring to your attention a particular issue we have seen occurring more frequently.  It relates to employee stock options and how custodians report cost basis which can lead to double counting gains (taxed as ordinary income). 

New custodian reporting requirements of employee stock options can drastically overestimate your tax liability if not corrected.  If you have had any stock options that vested in 2014 or later, you could be affected.

The reason 2014 is the important year is because that is the year new tax law went into place affecting stock options.  Any employee stock option “granted or acquired” on January 1, 2014 or later has different rules governing how the custodians (Schwab, Fidelity, Morgan Stanley, etc.) report cost basis. 

Prior to the rule change, reporting exercised employee stock options on your taxes was more straightforward.  A simple example is helpful.  You were given 1,000 shares of ABC non-qualified stock options in 2013 with a strike price of $50 per share.  They vested in 2018 when the stock price was $100 per share.  Below is a comparison of the most likely way your gains were reported under pre-2014 rules and post 2014 rules.

Exercising an employee stock option is different than a typical option you could buy yourself.  Because it is considered compensation from your employer, any gain is taxed as FICA wages.  It will show up on your W2. And because you pay tax on the gain immediately, the cost basis of your stock is now the price you sold the stock at, not the original strike price.  In the pre-2014 method it was common that the custodian that held your stock would make this adjustment, as shown in the example.  Or they would input “missing” for the cost basis, which would signal to the CPA prepping your return that this was a special case and the correct number should be given by you.

With the new tax law, custodians are no longer allowed to adjust employee stock options for the portion reported as FICA wages.  They are required to report the cost basis as the strike price with no qualifying note that there needs to be an adjustment.

If the CPA is not aware that you received employee stock options, there may be nothing to alert her that you have already been taxed on these options.  This potentially can lead to your income, in this scenario, to be reported $50,000 higher than it was.  The only way to fix this is make an adjustment on a separate tax form (Form 8949).

The bottom line is this:

If you have had employee stock options vest since 2014, it may be beneficial to double check how those were reported on your return.  It is very possible your taxable gain was added twice.

If you have employee stock options vesting in the future, make sure to check the 1099 issued by your custodian.  In all likelihood you will need to adjust your cost basis to avoid a potentially costly mistake.

Lastly, if you think this may apply to you, but you are not sure, please don’t hesitate to reach out to us.  We are happy to review your return.

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