Here are 4 big tax mistakes to avoid after stock option moves
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If you bought or “exercised” corporate stock options in 2021, you need to watch out for tax pitfalls when reporting, according to financial experts.
A stock option is the ability to buy stock in the company that employs you at a specific price, with the potential for profit if the value increases and you decide to sell.
These may include so-called non-qualified stock options, which add to your annual compensation and increase regular taxes, or incentive stock options, which do not increase income but may trigger other direct debits.
“The time to make a tax-and-exercise plan is before exercise,” said certified financial planner Kristin McKenna, managing director of Darrow Wealth Management in Boston.
But whether you exercised stock options in 2021 with or without a plan, mistakes can still happen at tax time. Here’s how to dodge four of the biggest mistakes.
When you exercise non-qualifying stock options, the rebate you receive or “spread” – the market value at exercise less the price you paid – is part of the annual compensation, deducted at the rates regular taxes and shown on your W-2.
For example, if you bought 100 shares for $20 and the market value that day was $30, the spread is the market value of $3,000 minus the purchase price of $2,000, which which adds $1,000 to your compensation.
The spread is grouped in box 1 of your W-2 with your salary, but it will also appear in box 12, explained Bruce Brumberg, editor and co-founder of myStockOptions.com.
However, since it is already part of box 1, you should not declare it separately, he said, or you will pay taxes twice on the same remuneration.
Although there is a statutory withholding tax of 22% if the discrepancy is less than $1 million, this may not be sufficient.
“There’s a certain level of protection there,” McKenna said. “But if you’re at $900,000, 22% just won’t do.”
Another common error with non-qualified stock options occurs when reporting the sale. If you sold these assets in 2021, your brokerage firm will send you Form 1099-B by mid-February, covering your profit or loss, which continues Form 8949 when filing your return.
However, there will be an error on 1099-B for your stock basis, or purchase price, shown in box 1e, Brumberg said, because unqualified stock options calculate the basis by adding the difference on exercise to your purchase price.
For example, if you paid $20 and the market value that day was $30, your exercise spread is $10, which is added to the purchase price of $20 for a basis of $30.
“Sometimes you will see on the forms [the basis] is completely omitted or sometimes only puts the strike price, which is inaccurate,” said Chelsea Ransom-Cooper, New York-based CFP and managing partner at Zenith Wealth Partners.
However, if you use the $20 basis, which may be shown in box 1e of your 1099-B, you will pay taxes on an additional $10 gain per share. In this scenario, you can correct the error by adjusting your profit or loss on Form 8949 in column g, Brumberg said. You can read more about this problem here.
Incentive stock options, another type of stock-based compensation, will not increase annual income. However, the exercised spread creates an adjustment for the so-called alternative minimum tax, or AMT, a parallel system for high earners, which may result in a higher bill.
“Everyone is still really nervous about AMT,” said Bryan Hasling, CFP and partner at Lodestar Private Asset Management in Alamo, Calif. “But it’s not so bad if you understand it.”
If you exercise incentive stock options and hold your shares, you will receive Form 3921 in January, and you have to run the calculation to see if you owe AMT, which removes some write-offs, instead of paying regular taxes.
When you owe AMT, you’re prepaying taxes that you can recover in years to come, Hasling explained. This is because it creates AMT credits that you can use to offset levies once the regular taxes exceed the AMT.
Of course, you will need to track AMT credits and share the details with your tax professional each year. Otherwise, they can’t check if you qualify.
“If you don’t tell your accountant, you’ve lost real money,” Hasling added.
If you’ve exercised stock options, it’s essential to track exercise prices, market values, and withholding taxes to compare with the details on your W-2 and 1099-B forms, a said Ransom-Cooper.
However, you can get organized now by logging into your stock options account and printing activity reports. You can also see how the numbers line up by looking at your year-end pay stub. “You can never give too much to a tax professional,” she said.
In the future, you could save money by working with an advisor before exercises and tracking every trade. And you can reduce headaches by saving copies of each confirmation and taking notes on pricing and tax withholdings, Ransom-Cooper said.
“Have it ready to go so you can really rely on professionals to make sure you’re not paying too much,” she said.