Restricted stock, restricted stock units (RSUs), and performance shares bring their own very special issues to tax returns. In addition, this tax season has many more changes in the reporting of stock sales on tax returns than in past years. It is easy to make expensive mistakes that lead to paying more than necessary or (perhaps worse) unwanted IRS attention. This tax season in particular has been more confusing than most because of the new IRS Form 8949 and the corresponding revisions to Schedule D, which has significantly changed upon the introduction of Form 8949. These alterations, in turn, stem from the expansion of the information that brokers must report on IRS Form 1099-B.
In any year, however, there are many potential costly mistakes that can befall taxpayers with restricted stock issues on their tax returns.
One Mistake: Double-Counting Income
When restricted stock vests, even if you don't sell any shares, the value of those shares at vesting will be treated as ordinary income and included in Box 1 on IRS Form W-2 with your other compensation, and in the other boxes for state and local income (see our related FAQ with a diagram of Form W-2). Companies may voluntarily break out the income in Box 14 ("Other").
This Box 14 reporting is not required and is done only to help you understand what part of the income reported in other boxes resulted from the restricted stock. When you fill in the line for "Other income" on your Form 1040 (Line 21 of the 2011 form), don't make the mistake of listing the amount shown in Box 14 of your W-2 or any income already included in Box 1 for stock compensation. That would be double counting.
Instead, you include this value of the stock at vesting on your tax return as part of your salary/compensation income on Line 7 of Form 1040. It's the same for restricted stock units, as long as all the shares are delivered at vesting (see another FAQ on RSUs with deferred delivery of shares).
Another Mistake: Waiting Until The Entire Grant Has Vested
For restricted stock that vests incrementally over a number of years (e.g. 25% per year), you realize and report for each year the W-2 income from the portion that vested during that year. Do not wait till the whole grant has vested—unless, of course, the grant vests all at once (i.e. cliff vesting).
However, if you made a Section 83(b) election (not available for RSUs or performance shares) to pay tax on the full value of the restricted stock at grant, you report the value in that tax year, and thus you do not later report the income from the value of the shares at vesting. Should you have performance shares or units that pay out when certain corporate goals are met (either yearly or at end of cycle), but the payout and share delivery occur in a different calendar year than the achievement of the goals, you report the income for the year in which you actually received the shares (i.e. not in the year when the goals were met).
Complex Topic; Many Potential Mistakes
Believe it or not, the two errors discussed above are just the beginning. Our exclusive article on tax-return mistakes with restricted stock lists a total of 10 common blunders to avoid. Want a quicker read? See the companion FAQ that also explains errors to avoid on tax returns that involve restricted stock, restricted stock units, or performance shares.
In general, the Tax Center at myStockOptions.com is a one-stop shop of information about the tax-return reporting and filing issues presented by stock compensation and employee stock purchase plans, including a special section with annotated diagrams of Form 8949 and Schedule D.