Receiving Options, RSU or Company Stock?

Receiving Options, RSU or Company Stock? Preparing Your Own Returns in Turbo Tax?

Eliminating These Costly Common Errors Will Save You Thousands in Taxes

Times and times again, I meet new clients who come to consult with a CPA who have been deeply frustrated with their recurring high tax bills. Most frequently, they prepare their tax returns in Turbo Tax. And why not? Their tax circumstances may be pretty simple: a W2 and a brokerage statement or two reporting stock sales.

An experienced tax professional will almost immediately (with the help of a few questions) be able to diagnose these very common problems that result in over-reporting of income from receipt of stock options, RSUs, company stock, other types of equity compensation, and sales of stock obtained through employer grants. It is always eye-opening how enormous the tax savings can be!

Error #1. Don't report taxable income twice!

A common error for employees who exercise employee stock options is to report their income twice. Ordinary income from exercising a non-qualified stock option or from the disqualified disposition of stock received from exercising an incentive stock option should be reported by the employer on Form W-2. Brokerage companies’ reporting on 1099 does not always take this element into consideration. The result is understatement of tax basis of the sold shares and inflated gain. This is especially a common error for employees who skip the "interview mode" when preparing their own income tax returns using software like TurboTax.

Proper calculation of the tax basis of exercised and sold shares will not only reduce, but can also eliminate all gain on the sale of stock.

Error #2. Remember to report the sale of option stock.

Employees who exercise their stock options and immediately sell the stock sometimes omit reporting the sale of the stock. They figure the income is already reported on their W-2 form. They are essentially right, but the IRS "matches" the income reported on income tax returns with information returns for the sale of securities issued by brokerage companies. The absence of reporting of stock sales and mis-reporting of tax basis, especially of so called “covered transactions” can lead to IRS notices and further complication of the taxpayer’s situation.

Error #3. Watch reporting qualified sales of ISO stock.

A common error for employees who make a qualified disposition of ISO stock is to add the AMT income reported for the year of exercise to the cost of the stock. Employees rationalize they have already paid income taxes for that income. However, the mechanism for recouping some of the AMT paid when the ISO was exercised is the minimum tax credit, reported on Form 8801. A second AMT Schedule D must be prepared for the year of sale with the AMT basis adjustment for the sale of the ISO stock. Again, such mis-reporting can lead to IRS notices and adjustments to the filed tax returns that would not be in favor of the taxpayer.

Error #4. Do not forget about reductions to gains on a sale of start-up stock.

Did you ever go through an acquisition of an early-stage company, IPO? Did you work for a start-up but changed jobs and years later received a 1099 showing the sale of the start-up company’s redeemed stock?

Most likely your acquisition cost of the liquidated stock was near zero. The capital gains and the associated tax bill can be huge.

Moreover, the tax filing time is months after the stock disposition took place and Turbo Tax is calculating hundreds or thousands of underpayment penalties on top of your federal and state tax liabilities. By this time, you might have already put the sale proceeds into a downpayment on the house, invested in a more diversified, target-date portfolio, or simply spent it. The tax deadline is approaching, but you barely have any liquid cash to make the tax payment with the returns.

It is possible that a great portion of the gain could be excluded from your income. There is quite a bit of testing to be done, and your CPA will interview you extensively. The end result will be the tax savings that will not only preserve cash in your accounts, but will relieve you of underpayment penalties and further tax bills.

Does this make your head spin? Are you nervous about making an error on the return? You are tempted to reduce your tax balance but are unsure whether it will trigger any unwelcomed audit inquiries or notices?

Maybe you should hire someone like us who understands the nuances of your income tax returns preparation and can defend them before the tax authorities with the full knowledge of intricacies of the tax law.