"April is the cruellest month," wrote the poet T.S. Eliot. It certainly can feel that way if you have not yet filed your federal tax return as the IRS deadline in April approaches—and especially so if you are daunted by the complexity of the tax rules that apply to equity compensation.
Special issues on tax returns arise with restricted stock and restricted stock units (RSUs). Mistakes can be painful not only because they can cause you to overpay your taxes but also because they may draw unwanted attention from IRS auditors. (Ouch, right?) Below is a brief review of the necessary tax documents and forms, followed by eight big tax-return mistakes to avoid with restricted stock and RSUs.
Restricted Stock And RSUs: Crucial Tax-Return Documents And Forms
When restricted stock vests or RSU shares are delivered, the full value of the shares at vesting is reported on your Form W-2. If you are not an employee, this income appears on Form 1099-MISC. Employees include this value on tax returns as part of 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 an FAQ on RSUs with deferred delivery of shares).
For restricted stock that vests over a number of years (e.g. 25% per year), you realize and report W-2 income with each vesting slice, not when the full grant is vested. One exception: if you made a Section 83(b) election (unavailable with RSUs) to pay taxes on the full value of the restricted stock at grant, you do not then report income again for the value of the shares at vesting.
If you sold stock during the tax year, you must file with your tax return IRS Form 8949 along with Schedule D, using what your brokerage firm reports to you on IRS Form 1099-B. In most situations, the cost-basis information on Form 1099-B for stock sales from equity compensation cannot be used "as is" for accurate tax-return reporting. If you do not understand the rules, you will overpay taxes (see a related FAQ).
Eight Big Mistakes To Avoid With Restricted Stock And RSUs
Most of the potential mishaps, presented below, concern the reporting of stock sales on Form 8949 and Schedule D.
1. After selling any or all of the shares at vesting, you still need to report this sale on Form 8949 and Schedule D even though you are also including it as part of your compensation income. You may even have some small gains or losses, depending on how your company calculates the stock value at vesting and any commissions and fees for the stock sale. (For an annotated example of how to report the restricted stock sale on these forms, see the related FAQ.)
Alert: If the IRS were to receive a report of your gross sale proceeds from your broker (on Form 1099-B) but without a corresponding report of the sale on your Form 8949, the IRS would think you had failed to report the gain on the sale. Assuming a tax basis of $0, the IRS computers would then automatically send you a notice for the taxes due.
2. Even though you never purchased the stock, your tax basis for reporting the stock sale in column (e) on Form 8949 is the amount of compensation income at vesting that appeared on your W-2 (you already reported it on your tax return). If you made a Section 83(b) election (not available for RSUs), the basis amount is the value at grant on your W-2. Do not assume that, because you did not pay any money to purchase the stock or exercise anything, your tax basis is zero. For the cost basis, Box 1e of your 1099-B may be blank (or show $0) only because brokers are not required to report the cost basis for noncovered securities, such as restricted stock and RSUs (some brokers may report the basis on the 1099-B that you receive but not on what they report to the IRS). Otherwise, you will pay double tax on the value of the shares at vesting. See a related FAQ with annotated diagrams of Form 8949 and Schedule D that show how you report stock sales after you have held the stock at vesting.
3. You will also mistakenly double-report income if you do not realize that your W-2 income in Box 1 already includes stock compensation income. Wrongly thinking it was left out may prompt you to erroneously report the income on your Form 1040 in the line for "Other income" (Line 21 on the 2015 form). Doing this will cause the income to be taxed twice as ordinary income. You use Line 21 only when your company mistakenly omits the income received at vesting from your W-2 or 1099-MISC.
4. If you surrendered or sold shares at vesting to pay the withholding tax (see our FAQ on withholding for restricted stock), you want to report any actual market sale of shares on your Form 8949. For a share surrender in which you receive only the net after-tax shares in your account, speak with your own tax advisor about the need to report this (see our related FAQ on the issue). Alternatively, if you sold only some of the shares (e.g. for taxes), you don't want to report on your Form 8949 the cost basis for all the shares vested. This would result in a much larger tax basis and a capital loss for these shares sold.
Alert: When you later sell the remaining shares in your grant, remember to exclude from your Form 8949 at that time the shares used earlier to withhold taxes (i.e. do not use the full number of granted shares). Otherwise you'll report more shares than you sold, as explained in a related FAQ.
To read four other crucial tips on tax-return reporting involving restricted stock and RSUs, see the full FAQ about this topic on myStockOptions.com. Also, see other FAQs for the biggest tax-return blunders to avoid with stock options, employee stock purchase plans, or stock appreciation rights.