Published on 27/03/2021

Allotment of Stock options by your company where you work under the Employee Stock Purchase Plan can be quite exciting. It comes with many perks, unfortunately, tax is not one of them. While the tax season can be grueling as it is, taxation with stock options in the picture can be tricky. Remember, you don’t want the IRS peeking into your accounts- which is why it is imperative to be as accurate as you can while filing taxes on employee stock purchase plans. Read on to know what mistakes to avoid when calculating taxes on these shares.

Failing to file Form 8949 after selling employee stocks

The sale of employee stock purchase plans is directly reported on the employee’s W-2 form. Even if you did not hold the stock for a long time, you will be required to report its sale on Form 8949. This is a form you fill when you report capital gains or losses on transactions from stock sales.

You will be required to fill the form irrespective of the amount of profit or loss and the time horizon the investment was held to before the shares were sold. If you fail to report the transaction and the IRS receives information about the same via a broker or dealer or any of its other sources, you may be issued a CP2000 notice demanding you to respond with your agreement or disagreement, which is simply more paperwork in addition to the fact that you need to pay taxes on the share sale you effected.

Paying an incorrect amount of tax

Even if you held on to your stock for over a year, you cannot claim  capital gains benefit on the full amount of your employee stock purchase plan. Your income from the investment sale in the year will be equal to the gains made on the sale or the price purchase discount you were offered at the beginning. Anything beyond the price purchase discount is considered a long-term capital gain.

Paying taxes early on the discount

Under some types of ESPPs, employees are allotted company shares after payroll deductions on a post-tax basis at a discounted rate of up to 15%. Taxpayers should not include this discount as their income if they haven’t sold the shares in the same year they bought them.

If you sold the shares off, you will end up with compensation income in the same year. To put it simply, you bought the shares at a discounted price and sold them in the fair market.

For ESPPs that are not tax-qualified, rules of Non Qualified Stock Options (NQSOs) apply, the details will be furnished in your Form W-2.

Paying double tax on the discount

When you have already filled the purchase discount in your Form W-2, the transaction will reflect in your income for the year. You could be taxed twice if you make the purchase discount a part of the cost basis when you sell the stocks. You can avoid making the cost basis in your Form thus avoiding the double taxes on your Form 1099-B.

Using cost basis directly from Form 1099-B

IRS mandates that the Form 1099-B issued by the broker shouldn’t carry the compensation amount as a part of the cost basis. For stocks purchased before 2011, Form 1099-B should only carry the purchase price and there is no need to include the compensation element.

Following this, necessary verifications and adjustments must be made when you fill Form 8949. 

Using the wrong price in case of no lookback

Having a lookback feature on your employee stock purchase plan can be beneficial to helping employees make accurate tax filing. This will help to keep the actual discount in check for you to get the best tax treatment. In the absence of one, note that the discount for calculating your income for the year from the sale of shares is calculated not from the price on purchase date but from the price on the first day of the offering period.

Claiming stock options from your company can be wonderful if you plan to keep them for years and sell them later. But if you are selling your stocks in the same year you purchased them, you may want to do your taxes even more carefully this tax season. Reach out to us at [email protected] with your queries.