Section 83(b) Election: Official IRS Form Coming Soon!

Update (Nov. 8, 2024): The IRS has officially introduced its new form for the Section 83(b) election, Form 15620.

Today we bring you news of a different election: the Section 83(b) election, a tax move that is available for restricted stock and early-exercise stock options. Last month, at the annual conference of the National Association of Stock Plan Professionals (NASPP) in San Francisco, a staff lawyer with the IRS Office of Chief Counsel revealed that the agency is finalizing an official IRS form for the Section 83(b) election.

In the equity comp world, this is a very big deal. There are various scenarios with equity compensation—specifically restricted stock, stock options, and LLC interests—in which making a timely Section 83(b) election with the IRS can be an important move for tax planning and minimization. However, currently no official IRS form exists for making that election.

Three Scenarios Involving The Section 83(b) Election

Below are three situations in which a Section 83(b) election is an action to consider.

Grant Of Restricted Stock

Grants of restricted stock are made by public companies and by private companies in the early startup stage (sometimes called founders’ stock). When you receive a grant of restricted stock, the grant must vest before you own the shares. Normally, the value of the grant is taxed at the time of vesting. However, you can instead choose to pay tax on the value of the stock at grant (minus anything you paid for the stock) by making a Section 83(b) election with the IRS within 30 days of the grant date.

Essentially, by making the 83(b) election you are betting that the stock will appreciate substantially between grant and vesting, so you choose to be taxed on what you hope will be the lower value at grant. Additionally, you make an early start on the one-year holding period you must meet to be taxed at the long-term capital gains rate (lower than the short-term rate) when you sell the shares.

Note that the 83(b) election is not available for restricted stock units (RSUs).

Early-Exercise Stock Options

For employees in private companies who receive early-exercise stock options, i.e. options that can be exercised before vesting, an 83(b) election within 30 days of exercise is needed to change the regular tax treatment. You essentially purchase restricted stock with the same vesting schedule that the options had and pay taxes at exercise on any income from the spread (i.e. the difference between the stock’s fair market value and the exercise price). You also get an early start on the holding period for long-term capital gains.

LLC Interests

A limited liability company (LLC) has membership interests rather than shareholders. It can make equity-compensation-type grants in the form of profits interests or capital interests. Profits interests are more common, particularly for private-equity-backed companies.

Depending on how the grants are structured (a complex topic beyond the scope of this article), most tax professionals recommend an 83(b) election within 30 days of grant. With the right structure, these interests often have zero value at grant—i.e. no taxable income at that time—and long-term capital gains tax treatment at sale when the interests are held long enough.

Timing Of 83(b) Election Is Crucial

To be valid, a Section 83(b) election must be mailed to the IRS within 30 days of the grant date for restricted stock and LLC interests or the exercise date for early-exercise options. You send it by certified mail (return receipt requested), postmarked within that 30-day period, to the IRS Service Center where you file your tax return.

Currently, however, the IRS does not have an official form for the 83(b) election. You make the election in correspondence to the IRS that you or your tax advisor prepare, including all of the required information as indicated by guidance from the IRS. You also give a copy to your company.

This approach increases the risk of improperly filing the election or missing the deadline, which would make it invalid. Once the 30-day window has elapsed, you can’t make the 83(b) election to be taxed at the earlier time—with painful tax consequences should the underlying equity’s price later surge.

83(b) Election Carries Risks

The Section 83(b) election has risks. Once you have made the election and paid taxes, you cannot get those taxes back from the IRS if your employment ends before vesting or the equity becomes worthless. Should one of those outcomes occur, you may end up paying taxes on income that you never receive!

Moreover, unless you can prove to the IRS that you made a “mistake of fact” (very difficult to do), it’s almost impossible to revoke an 83(b) election after the initial 30-day election window of time. Therefore, you should speak with a tax professional (CPA, Enrolled Agent, lawyer) to be sure you understand how and why you are making this tax election.

New IRS Form Will Make 83(b) Election Much Easier

The welcome new Section 83(b) election form, expected to be IRS Form 15620, will be available as a downloadable PDF with fields for all the required information. I discovered that this new tax form is already listed in the long document table in an early September IRS notice on various topics published in the Federal Register. 

At first, the form will be mailed to the IRS, but under the IRS modernization program it will eventually be submissible by e-filing. The new form is far along in its development, I was told in a separate discussion with my IRS source, and it may be released this year.

See myStockOptions.com for more details on taxation, planning, and risks with the 83(b) election and on early-exercise stock options in startup/pre-IPO companies.

SPECIAL WEBINAR

Year-End & Year-Start Equity Comp Financial Planning

Thursday, Nov. 14 (2pm–3:40pm ET, 11am–12:40pm PT). See the webinar registration page for a detailed agenda. 2.0 CE hours for CFP, CPWA/CIMA, CEP, CPE, and EA

Join us for this lively webinar on year-end 2024 and year-start 2025 strategies for stock options, restricted stock/RSUs, ESPPs, and company stock holdings to help you make smarter decisions and prevent costly mistakes. In 100 minutes, a panel of leading financial advisors will present practical insights and real-world case studies:

• John P. Barringer (CFP®), Executive Wealth Planning
• Rebecca Conner (CFP®, CPA/PFS™, RLP), Founder, SeedSafe Financial LLC
• John Owens (CFP®, EA, ECA, CPWA®), Managing Partner, Brooklyn FI

Uncertainty about tax rates as the TCJA sunsets and the unpredictable future of the current stock-market boom make the need for expert guidance more important than ever, as this webinar will cover.

Register now. Time/date conflict? No problem! All registrants get the webinar recording, slide deck, and handouts.

IRS Audits Of Equity Comp: New IRS Guide Shows What To Expect

An IRS audit: a prospect that provokes stress and anxiety. Even if you are not personally targeted for an audit, an IRS audit of your company's equity compensation can still put you on the hook. Depending on what IRS examiners find, a company audit can lead to individual audits and amended personal tax returns for executives and employees.

The IRS recently surprised tax experts by issuing a new version of its stock compensation auditing guide, which had not been updated since 2015. Developed as an internal manual for IRS employees, it also offers businesses a helpful window into what IRS agents examine in audits related to all types of equity compensation. It’s a heads-up on stock options, restricted stock, restricted stock units (RSUs), stock appreciation rights (SARs), phantom stock, and employee stock purchase plans (ESPPs) for anyone who has these benefits or advises clients with them.

Professionals and taxpayers alike should review the guide to avoid pitfalls and tax situations that could trigger a dreaded IRS audit—the worst of which has been vividly described by tax attorneys as “an autopsy without the benefit of death.”

What IRS Agents Inspect With Stock Options And ESPPs

The IRS manual is called the Equity (Stock) - Based Compensation Audit Technique Guide. It gives IRS examiners a roadmap for audit scrutiny into when income should have been recognized, reported, and subjected to withholding, along with the related records, documents, and terms to review. In some ways, it also provides a brief general review and summary of equity comp taxation and IRS interpretations of the Internal Revenue Code (IRC).

As publishers who takes pride in the clear plain-English explanations of tax rules offered on myStockOptions.com, we could quibble with the IRS-speak and some inaccurate interpretations of the IRC in the audit guide. However, for now, let us simply highlight some issues the guide instructs IRS examiners to focus on in their search for tax errors:

• Loans to exercise options to ensure that they are recourse loans (i.e. you personally pay should you default) and whether they were forgiven/canceled or reduced.
• Qualifying and disqualifying dispositions for incentive stock options (ISOs) and tax-qualified ESPPs. These are shares from ISO exercises or ESPP purchases that were sold either before or after the statutory holding periods of two years from grant and one year from exercise/purchase that provide the best tax treatment.
• Annual limits on the size of ISO grants (only $100,000 can be vesting/first exercisable in one year) and ESPP purchases ($25,000 annual limit). While your company probably has a stock plan administration program to help it adhere to these limits (which are not adjusted for inflation), company mistakes can change your tax treatment by turning your ISO grant and ESPP into nonqualified stock options.
• Restrictions on transferred stock that create a substantial risk of forfeiture (SRF) which needs to lapse before taxes apply. The SRF concept is standard, for example, with most grants of restricted stock or RSUs, which must vest before you recognize taxable income and could be forfeited if you were to leave the company before the vesting date. A stock buyback right for your company at job termination is not seen by the audit guide as an SRF that postpones income recognition, as it defines those as “non-lapse restrictions.”
• Transfer of stock options to related persons, which makes them a “listed transaction” and could be an abusive tax shelter.
• Company reporting requirements for your ISO exercises (on Form 3921) and ESPP purchases (on Form 3922).
• Form W-2 reporting, including special reporting and codes for nonqualified stock options and other grants.
• Appropriate amounts and timely deposits of withholding for federal income tax, FICA (Social Security and Medicare), and FUTA.
• Timely IRC Section 83(b) elections for the early-exercise stock options used by private companies. Also for startups, whether any elections were made under IRC Section 83(i) to defer income.

IRS Collection Efforts Have Intensified, Including Audits

The updated audit guide also reflects the ways in which the IRS directs more audit attention toward higher-income taxpayers. The IRS has intensified its efforts in that area during recent years.

In 2023, the IRS announced a special focus on ensuring that large corporations and rich individual taxpayers pay taxes owed. In particular, the IRS said it is “ramping up efforts” to pursue high-income, high-wealth individuals who have not paid their taxes. The agency is concentrating in particular on roughly 1,600 US taxpayers with more than $1 million in annual income and over $250,000 in federal tax debt. Simultaneously, the IRS reassured middle-class taxpayers that audit rates would not increase for yearly incomes of under $400,000.

The initiative to collect past-due taxes from delinquent millionaires has paid off significantly. In early 2024, the IRS revealed that it had recovered more than $482 million in previously unpaid taxes. Just this month, the IRS reported that it had collected over $1 billion in past-due taxes from the target group. The agency stated that the revenue to that point represented payments from over 1,200 of the 1,600 targeted millionaires.

These efforts are funded by the $80 billion in additional multi-year funding that the IRS received under the 2022 Inflation Reduction Act. The agency wants to reduce the embarrassingly wide $688 billion gap between estimates of the amount of tax owed each year and the amount that is voluntarily paid.

Likelihood Of Getting Audited: Data On IRS Audit Activity

In general, the more you make, the more likely you are to be audited by the IRS. Sudden income spikes, such as income from a stock option exercise or the vesting of RSUs, are a red flag that can trigger an audit.

The IRS periodically publishes information about its general audit activity. The latest update, the 2023 IRS Data Book, covers the IRS fiscal year from October 1, 2022, through September 30, 2023. It reveals the following facts:

• Over the decade preceding 2023, the IRS examined tax returns filed by 8.7% of taxpayers with income of more than $10 million; 3.1% of taxpayers with income of $5–10 million; and 1.6% of those with income of $1–5 million.
• In 2023, the IRS completed 582,944 tax-return audits, resulting in nearly $32 billion of extra tax revenue.
• Most audits in 2023 (77.3%) were conducted via correspondence; 22.7% were conducted “in the field.”

Increasingly, IRS computers automatically check tax-return accuracy. The Automated Underreporter Program compares income in tax returns with IRS data. When the computers find a discrepancy, they automatically issue a notice (CP-2000) requesting an explanation.

CP-2000 Notice For Not Reporting Company Stock Sales Accurately

For example, when you immediately sell all shares acquired from a vesting of restricted stock or exercise of stock options, you may think you do not have taxable income beyond the ordinary income reported on your W-2, as there was no capital gain upon the stock sale. However, even in this situation, you must report the stock sale on IRS Form 8949 and Schedule D of your Form 1040 tax return, as the IRS still receives Form 1099-B from your brokerage firm to report the sale. If the sale is not also reported on your IRS forms, the IRS will send you a CP-2000 notice looking for you to pay taxes on the full amount of the sale proceeds!

Additional Tax Resources

For additional tax resources on all types of equity compensation and ESPPs, including tax-return reporting, see the Tax Center on myStockOptions.com.

myStockOptions Webinars

See the myStockOptions Webinar Channel for upcoming webinars and past webinars on demand. Each webinar offers CE credits for CFP, CPWA/CIMA, CEP, EA (live webinars only), and CPE (live webinars only), plus CFA self-determined credits. Featured experts present real-world case studies. On-demand webinars are listed below. Click on the links to register now!

FUNDAMENTALS

• Equity Comp Masterclass (Part 1): Stock Options

• Equity Comp Masterclass (Part 2): Restricted Stock/RSUs & ESPPs

• Stock Compensation Bootcamp For Financial Advisors

• Stock Comp Tax Essentials: Crash Course

ADVANCED

• Equity Comp Masterclass (Part 3): Best Ideas From Top Advisors

• Restricted Stock & RSU Financial Planning: Insights From Leading Advisors

• Stock Option Exercise Strategies: Managing Risk & Building Wealth

• Year-End Financial & Tax Planning For Equity Comp

• Preventing Tax-Return Mistakes With Stock Comp & Stock Sales

SPECIALIZED

• Stock Comp Financial Planning For Private Company Employees: From Startup To IPO Or Acquisition

• 10b5-1 Trading Plans And Other SEC Rules Advisors Must Know

• Strategies For Concentrated Positions In Company Stock

• Negotiating Equity Comp At Hire & Protecting It In Job Termination

Retirement-Planning Alert: How 2024 IRS Limits On Tax-Qualified Plans Affect Nonqualified Deferred Comp

Executives and highly compensated employees often have both equity comp and the opportunity to participate in a nonqualified deferred compensation (NQDC) plan. For many NQDC plan participants, it’s time again to make like an autumn squirrel and decide how much to store for the future. In November and December, they must decide how much of next year’s salary to defer.

Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans. The IRS just set the qualified plan limits for 2024. That’s crucial info for employees and executives who can participate in company NQDC plans.

How The 2024 IRS Qualified Plan Limits Affect Nonqualified Deferrals

Generally, you defer income via nonqualified plans only when you know you will max out your yearly contributions to qualified plans. Therefore, the contribution limits set by the IRS on qualified plans, adjusted annually for inflation, are important for NQDC planning.

If you’ve already maxed out your qualified plan contributions for 2023, you will probably do the same in 2024, so you will need NQDC plans to defer any salary and bonus increases you expect in 2024. Your motivation to defer may be boosted further if you believe tax increases are on the way and will affect you.

2024 IRS Contribution Limits For Qualified Plans

The IRS changes in limits for 2024 are much smaller than the increases for 2023 because these adjustments are based on the inflation rate, which has moderated. Here are the key annual contribution limits on qualified retirement plans for 2024, along with the 2023 limits for comparison:

Contribution type/limit	2023	2024
Compensation limit in qualified deferral and match calculation	$330,000	$345,000
Elective compensation deferrals, such as 401(k) and 403(b)	$22,500	$23,000
Catchup contribution for people aged 50 or older	$7,500	$7,500
Total defined contribution limit (employee and employer contributions)	$66,000 + catchup contribution	$69,000 + catchup contribution
Defined benefit plan payout limit	$265,000	$275,000
Income threshold defining key employees for top-heavy plans and six-month delay on payout upon separation	$215,000	$220,000
Income threshold defining highly compensated employees for nondiscrimination testing; this also applies to income point where companies can exclude employees from a tax-qualified ESPP	$150,000	$155,000

Qualified Versus Nonqualified Retirement Plans

The yearly contribution limits for qualified retirement plans are a big reason why companies offer nonqualified plans: to let executives and other highly compensated employees save extra money for retirement with an elective nonqualified plan or an excess 401(k) plan. The deferred income is “nonqualified” because it does not fit the rules in the tax code that allow tax-qualified plans, such as 401(k) and 403(b) plans.

Nonqualified deferred comp allows you to put away amounts beyond the permissible contribution amounts of standard qualified retirement plans. For retirement planning, it can therefore bridge the considerable gap that arises between the amount of income that you will actually need in retirement and the amount of income that can be provided via your 401(k) plans and Social Security.

Nonqualified Deferrals Have Complex Rules

Nonqualified deferred compensation plans and their participants must follow the complex rules under Section 409A of the US tax code. These rules govern your deferral and distribution elections. The amounts that you defer can only be informally funded by your company, and they are at risk should the company enter bankruptcy proceedings.

The website myNQDC.com is a comprehensive resource on NQDC plans, including the basics, the deferral/distribution process, the risks, and the related financial and tax planning.

Social Security Wage Cap Also Rises In 2024

Set by the Social Security Administration, the Social Security wage cap will rise to $168,600 in 2024, up from $160,200 in 2023.

With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $9,932.40 in 2023 and will rise to $10,453.20 in 2024.

Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

Further Resources

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC.com. See also the website’s FAQ on the top NQDC-related issues in year-end planning.

myStockOptions Webinars

See the myStockOptions Webinar Channel for upcoming webinars and past webinars on demand. Each webinar (100 mins) offers 2.0 CE credits for CFP, CPWA/CIMA, CEP, EA (live webinars only), and CPE (live webinars only), and 1.5 CFA self-determined credits.

Restricted Stock & RSU Financial Planning: Insights From Leading Advisors. Practical expertise, including case studies, on planning for restricted stock/RSUs from three leading financial advisors in this special niche.

Stock Option Exercise Strategies: Managing Risk & Building Wealth. It is crucial to have a plan for option exercises. This webinar features compelling strategies from a panel of three experts in financial and tax planning for stock options.

Stock Compensation Bootcamp For Financial Advisors. Whether you are new to stock comp or want to sharpen your knowledge, our bootcamp webinar provides practical information and insights to maximize success.

Stock Comp Tax Essentials: Crash Course. A lively overview of the critical tax rules at key stages for all the major forms of stock compensation: from exercise, vesting, or purchase to the sale of the shares; from tax withholding to tax-return reporting.

Strategies For Concentrated Positions In Company Stock. Wealth is won and lost through the management of concentrated company stock positions. In this webinar, four experts at managing concentrated stock wealth explain strategies and solutions.

Preventing Tax-Return Mistakes With Stock Comp & Stock Sales. Understand the rules of tax-return reporting for stock options, restricted stock/RSUs, ESPPs, and sales of company shares. Learn how to avoid common mistakes that lead to overpaid tax or unwanted IRS attention.

Stock Comp Financial Planning For Private Company Employees: From Startup To IPO Or Acquisition. Equity comp in private companies is different. Learn the related financial and tax planning with three leading financial and tax advisors, including real-world case studies.

Negotiating Equity Compensation: How Advisors Can Help Clients. Learn the best ways to evaluate and negotiate equity compensation in job offers and how to protect it at job termination.

10b5-1 Trading Plans And Other SEC Rules Advisors Must Know. Learn the fundamentals, mechanics, and best practices for Rule 10b5-1 trading plans. This webinar features top legal and financial experts presenting practical guidance and real-world case studies for financial advisors.

Year-End Financial & Tax Planning For Equity Comp. Boost your knowledge of year-end and year-start strategies for stock options, restricted stock/RSUs, ESPPs, and company stock holdings to help you make smarter decisions and prevent costly mistakes.

2023 Tax Planning: The 3 Numbers All Employees Should Know

Before tax-return season sets in, putting your focus on your 2022 income, this is a good time to meditate on your tax planning for 2023. That includes the federal tax-related numbers for 2023 that are crucial for all employees, their paychecks, and their planning.

The IRS and the Social Security Administration annually adjust for inflation a myriad of key numbers in federal tax-law provisions—and in 2023, given the economic cycle we're in, some of these changes are bigger than in past years. However, it can be difficult to spot the adjustments that matter to you.

Some apply only to very high-net-worth executives and other super-wealthy people. For example, there's the federal estate-tax exemption (in 2023, $12.92 million for single taxpayers and $25.84 million for married joint filers). Others of interest mainly to administrators of corporate benefit plans and other experts (like us here at myStockOptions) who keep track of this stuff. For example, the income definition of “highly compensated employee,” which affects eligibility for employee stock purchase plans (ESPPs) and 401(k) plan non-discrimination testing, is $150,000 in 2023.

This article clears away all that to focus your mind on the essential points for you. Below are the top three sets of tax figures in 2023 that all employees should know. They relate to compensation from work: paycheck withholding, the potential need for estimated taxes, and your retirement savings.

1. The Social Security Wage Base

The Social Security tax (at a rate of 6.2%) applies to wages up to a maximum amount per year that is set annually by the Social Security Administration. Income above that threshold is not subject to the Social Security tax. (By contrast, the Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level.)

In 2023, the Social Security wage cap is $160,200, up from $147,000 in 2022. This means the maximum possible Social Security withholding in 2023 is $9,932.40. Once your income is over the wage cap and you’ve maxed out the withholding, you’ll see 6.2% more in your paycheck!

2. Your Income-Tax Bracket And Withholding

If you’re an employee, your company withholds taxes from your paycheck according to the information on your Form W-4. Showing the federal income-tax brackets and their rates, the table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate, i.e. the percent of tax you pay for an additional dollar of income in your current tax bracket. That number tells you whether the withholding as indicated on your W-4 will cover the total tax you will owe for 2023. To avoid “penalizing” additional income in your mind, be sure you know your effective or average tax rate.

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies do not use your W-4 rate for this income. Instead, they apply the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly supplemental income in excess of $1 million).

As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% does not cover all of the taxes that you will owe on supplemental wage income. In that case, you must either put extra money aside for the 2023 tax return you will file in 2024, pay estimated taxes during 2023, or adjust your W-4 for your salary withholding as soon as possible to cover the shortfall. Speak with a qualified tax professional, such as a CPA or Enrolled Agent, when you’re uncertain about the best approach to take.

If estimated taxes are the route you choose, know that due dates for quarterly estimated tax payments in the 2023 tax year are April 18, June 15, and September 15 of 2023 and January 16 of 2024. (The IRS routinely postpones these due dates for taxpayers in areas of the United States affected by natural disasters. See the IRS website section Tax Relief In Disaster Situations.)

3. Your Contribution Limit For Qualified Retirement Plans

In 2023, you can elect to defer up to $22,500 from your paychecks into qualified retirement plans, such as your 401(k). That annual limit increased from $20,500 in 2022.

The total ceiling for deferrals to defined contribution retirement plans, including any extra part contributed by your employer, rose to $66,000 in 2023, a $5,000 increase over last year’s amount. If you are 50 or older, you can contribute an additional $7,500 per year, a limit that also went up in 2023.

The amount of compensation income that can be considered in the calculation for qualified deferrals grew to $330,000 in 2023. Check with your company’s 401(k) plan administrator for the process of making changes in your compensation deferral election.

Want To Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan. For more on these plans, see the website myNQDC.com.

Inflation Adjustments For Health Savings Accounts (HSAs)

While not all employees have them, health savings accounts (HSAs) are also getting an increase in their pre-tax contribution limits for 2023 in response to inflation. HSAs are available only for high-deductible health plans.

The IRS has raised the yearly contribution limit for HSA self-only coverage to $3,850, up by $200 from last year, and for family coverage it is now $7,750, up from $7,300 in 2022. The limit for HSA catch-up contributions, available for people ages 55 or older, remains $1,000. With more companies setting up pre-tax payroll deductions for HSAs and matching employee contributions, these increases could be significant for many people as the cost of health care continues its relentless rise.

IRS Resources

Here are resources with more details on the many adjusted 2023 tax numbers:

• Revenue Procedure 2022-38 gives inflation adjustments in various income-tax-related provisions for 2023, which are also summarized in a more reader-friendly IRS news release.
• IRS Notice 2022-55 gives the annual adjustments in 2023 for various tax-qualified retirement plans.
• Revenue Procedure 2022-24 has details on the HSA contribution limits for 2023.

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WEBINAR: Preventing Tax-Return Mistakes With Stock Comp & Stock Sales

Wednesday, February 15
2pm–3:40pm ET, 11am–12:40pm PT
2.0 CE credits for CFP, CPE, EA, CPWA/CIMA, CEP, ECA

This tax season brings extensive risk for mistakes with tax returns involving stock comp. Complications in tax reporting due to the volatile markets of 2022, along with more IRS agents for audits, make the need for expert tax guidance more important than ever.

Register for this lively educational webinar on tax-return topics for stock comp. In 100 minutes, it will feature insights from three tax experts on issues with tax returns involving equity comp and sales of company shares. The panelists will present real-world case studies on how to use information in tax returns to create better financial plans.

For a detailed agenda of topics covered, see the webinar registration page.

Time conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the presentation slide deck. Therefore, even if you have a time conflict, please still register, as you will receive a link to the recording and presentation.

Tax Season 2022: myStockOptions Tax Center And Webinar Have Key Guidance To Help Prevent Costly Mistakes

Once again, the IRS has assigned us all homework due by mid-April. For tax returns involving equity comp and stock sales, the reporting has changed yet again for the 2022 tax-return season (income received in 2021). The changes, including where to put income left off Form W-2, expand what you must understand before you prepare your tax return.

With these and the many other tax changes of recent years, the 2022 tax-filing season presents more risk than ever for expensive errors on tax returns. Taxpayer mistakes can lead to overpaid tax, underreported income, IRS penalties, or even an IRS audit.

myStockOptions Tax Center: Valuable Tax-Return Resources

The fully updated myStockOptions Tax Center provides expert yet easily readable guidance on the filing and reporting of tax returns that involve stock options, restricted stock, restricted stock units (RSUs), performance shares, stock appreciation rights, and employee stock purchase plans (ESPPs).

An article and FAQ summarize changes in forms and reporting that taxpayers with stock compensation must know:

• Tax Season 2022: What You Need To Know About New Reporting Rules
• What's new for the 2022 tax-return season?

Other core articles and FAQs spell out the most common mistakes people make with stock grants on their tax returns. These include:

• 12 Tax-Return Mistakes To Avoid With Stock Options And ESPPs
• Restricted Stock & RSUs: 10 Mistakes To Avoid On Your Tax Return

You, your financial advisor, and your CPA can quickly run through these to be sure you submit error-free returns.

To get even more in-depth help with tax returns:

• The reporting of stock sales is made clear by special FAQs with annotated how-to diagrams of IRS Form 8949 and Schedule D.
• Diagrams of Form W-2, Form 3922 (for employee stock purchase plans), and Form 3921 (for incentive stock options) show how companies report equity compensation income to employees.
• An animated video explains how to avoid costly mistakes that can lead to the overpayment of taxes.
• Engaging podcasts convey tips for tax returns.
• A fun interactive quiz on tax-return topics lets users test their reporting knowledge in a painless way, before they file their returns, and links to related content from the answer key.

On-Demand Webinar About Preventing Tax-Return Mistakes

Held live on March 3 and now available on demand, the myStockOptions webinar Preventing Tax-Return Errors With Stock Comp And Stock Sales features insights from a panel of tax experts on how to avoid errors with tax returns involving equity comp and sales of company shares. It also offers special insights from panelist case studies on how to use information in tax returns to create better financial plans. The webinar recording offers 2.0 CE credits for the CFP, CEP, and CPWA/CIMA designations.

Panelists:

• Stephanie Bucko, CPA, CFA®, Mana Financial Life Design
• Dan Hodgin, CPA, Silicon Valley Tax Group
• Daniel Zajac, CFP®, EA, Zajac Group
• moderator: Bruce Brumberg, JD, editor-in-chief of myStockOptions

A detailed agenda is available at the webinar on-demand page.

Know Before You File

Remember that accountants and tax advisors sometimes make mistakes, so even if your return is being handled by a preparer, it's good to know the reporting. The last thing you want for your tax return is to pay too much tax, incur IRS penalties, or draw unwanted IRS attention leading to an audit.

Changes In IRS Form 1040 Affect Tax Returns Involving Stock Options, RSUs, ESPPs

As if tax returns involving stock compensation weren't complicated enough to begin with, tax-return reporting has changed yet again for the 2022 tax-return season. If you had income in 2021 from equity compensation, whether from stock option exercises, restricted stock/RSU vesting, or sales of company stock, this article explains what you need to know about IRS tax returns in the 2022 tax season.

The Changes In Brief

While the IRS Form 1040 for 2021 remains at 38 lines, changes have been made in its supporting forms. In 2018, the IRS condensed Form 1040 from its prior 79 lines in an effort to make it “postcard size.” It shifted many of those lines to supporting “schedules” that funnel information to Form 1040. The IRS has made changes in some of those schedules:

• Schedule 1 (“Additional Income and Adjustments to Income”) is where you should enter (under the expanded entries for “Other Income”) the amount of any stock compensation you earned as an employee that was mistakenly omitted from your Form W-2. In the past, it was unclear where and how to report this income.
• Schedule 2 (“Additional Taxes”) now has dedicated lines for amounts coming from the tax form for the Additional Medicare Tax on compensation income and the tax form for the Net Investment Income Tax (e.g. on capital gains and dividends from company stock).
• Schedule 3 (“Additional Credits and Payments”) now has a specific line for any credit for prior minimum tax. This would apply to anyone with incentive stock options (ISOs) who has triggered the alternative minimum tax (AMT).
• The totals on Schedule 1, Schedule 2, and Schedule 3 of Form 1040 appear on different lines on those schedules, but are entered on the same lines of Form 1040.

Highlights Of Form 1040

For the reporting of stock comp income and sales of shares, below are key aspects of the Form 1040 tax return and its associated schedules and forms, along with other details of the changes outlined above for the 2022 tax season.

1. Compensation. Stock compensation, along with salary income reported on Form W-2, is entered on Line 1 of Form 1040 (see image below).

2. Capital gain or loss. If you sold shares during the 2021 tax year, you enter each sale on Form 8949 and report the total on Schedule D. You then report that Schedule D total on Line 7 of Form 1040 (see image below). After three straight years in which capital gains reporting changed on Form 1040, it remains the same on the 2021 tax year return.

For stock sales, there is still no change in the IRS rules on how the cost-basis information is reported on Form 1099-B and Form 8949. Brokers are prohibited from including equity compensation income as part of the cost basis reported on Form 1099-B. This creates tax-return confusion and complications, as only the exercise cost (i.e. what you paid for the shares) appears on the 1099-B. To avoid the risk of overpaying taxes, you need to make an adjustment on Form 8949.

For restricted stock/RSUs, confusingly, the cost basis reported on Form 1099-B is zero or the box is left blank. However, the correct cost basis is the value of the shares at vesting. That is what you need to report on Form 8949.

3. Alternative minimum tax (AMT). A concern for anyone with incentive stock options (ISOs), the AMT is calculated on Form 6251. The spread at ISO exercise is reported on Line 2i if the ISO stock was not sold in the calendar year of exercise. If the ISO stock that triggered the AMT was sold, the difference from the ordinary tax is reported on Line 2k. You enter your Form 6251 calculation on Line 1 of Form 1040’s Schedule 2 (“Tax”). You attach Form 6251 to Schedule 2. The totals from Part I of Schedule 2 go into Line 17 on Form 1040.

The AMT credit that is generated for an ISO exercise that triggers the AMT is recouped through Form 8801, as it was in the past. The amount from Line 25 of Form 8801 goes into Schedule 3 (“Non-Refundable Credits”) on Line 6b, “Credit for prior year minimum tax.” This is the first tax year the AMT credit has its own line on the schedule. The totals from Part I of Schedule 3 go into Line 20 of Form 1040.

4. Equity compensation income left off W-2. If your company does not report your employee stock compensation on Form W-2 and does not later send you a corrected W-2c, the revised Schedule 1 for the 2021 tax year indicates that the amount goes in the “Other Income” section on Line 8j (“Stock Options”).

The list of items “a” through “p” (plus “z”) under “Other Income” on Schedule 1 is new for the 2021 tax year. Previously, taxpayers listed the type of other income and the amount, or put the details in a supplemental attachment. The total for other income from Schedule 1 goes into Line 8 of Form 1040.

Alert: The IRS expects you to report and pay tax on income mistakenly left off your Form W-2. An error by your employer does not release you from that obligation.

In the instructions for Form 1040 (pages 86–87), the IRS directs that the section “Other Income” on Schedule 1 is where to put any employee stock option income that is not on your Form W-2 and is therefore not reported on Line 1 of Form 1040:

Line 8j—Stock options. Enter on line 8j any income from the exercise of stock options not otherwise reported on your Form 1040 or 1040-SR, line 1.

Before this development, some tax experts thought this “Other Income” category was not for compensation-related income (only for non-wage income). Instead, they believed taxpayers needed to add the unreported W-2 income to wages reported on Line 1 of Form 1040. However, a non-match of W-2 Box 1 and Form 1040 Line 1 can raise red flag with IRS computers.

“Clearly, stock option income left off the W-2 should not be reported on the ‘wages and salaries’ line on form 1040,” explains Elliott Puretz, a CPA and retired college accounting professor in the Boston area. “From my review of Schedule 1 and the worksheets that support it, it appears that Line 8j is the line for it.”

Unresolved issues with this change in Schedule 1 include the question of how broadly to read the IRS instructions. It can be assumed to apply to all stock options, and probably ESPPs too. The IRS often uses the term exercise for purchase and refers to ESPPs as stock options. However, the instructions do not address how to handle restricted stock/RSUs. For these equity awards it is the vesting that triggers the taxable event and no exercise applies. The IRS has not yet responded to my requests for clarification.

If you are not certain that all equity compensation earned as employee left off the W-2 goes on Line 8j, then it can fit into Line 8z (“Other Income. List type and amount”). “RSUs are not stock options, so any income for those not reported as wages would presumably be reported on line 8z,” suggests Michael Gray, a CPA in San Jose (California) and a co-author of Secrets Of Tax Planning For Employee Stock Options.

5. IRS Form 1099-NEC for nonemployees. For employees, tax withholding occurs at NQSO exercise or restricted stock/RSU vesting, and the income should appear on Form W-2, as explained above. For nonemployees, such as consultants and directors, there is no withholding and the income from exercise or vesting now appears on IRS Form 1099-NEC (“Nonemployee Compensation”) as self-employment income. (Before 2020, it was Form 1099-MISC.)

Income is reported on Form 1099-NEC in Boxes 1 and 7. You report this income on Schedule C of your Form 1040 tax return. As the income is self-employment income, you also need to calculate on Schedule SE any Social Security and Medicare taxes that you owe.

6. Estimated taxes. The flat rate for federal supplemental withholding that applies to stock compensation (22%, but 37% for amounts over $1 million) may not cover the actual taxes you owe according to your marginal tax rate. You may have paid estimated taxes because of additional income from restricted stock/RSU vesting, an NQSO exercise, an ISO exercise/sale, or an ESPP purchase/sale. On the 2021 Form 1040, estimated tax payments are reported on Line 26.

Additional Tax-Reporting Resources

For guidance on the tax-return reporting for stock compensation and sales of company shares, including annotated diagrams of Form W-2, Form 8949, Schedule D, Form 3921, and Form 3922, see the Tax Center on myStockOptions.com.

 

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WEBINAR: Preventing Tax-Return Errors With Stock Comp And Stock Sales

March 3, 2pm–3:40pm ET, 11am–12:40pm PT
2.0 CE credits for CFP, CEP, CPWA/CIMA, and EA

This tax season brings more risk than ever for expensive mistakes with tax returns involving stock compensation, including cost-basis reporting for stock sales.

Register for this lively educational webinar on tax-return topics for stock comp. In 100 minutes, the webinar features insights from a panel of tax experts on issues with tax returns involving equity comp and sales of company shares, including how to avoid costly mistakes. The panelists will also present real-world case studies on how to use information in tax returns to create better financial plans.

For a detailed agenda of topics covered, see the webinar registration page.

Time conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the presentation slide deck. Therefore, even if you have a time conflict, please still register, as you will receive a link to the recording and presentation.

NQDC Alert: New 2022 IRS Limits For Qualified Plans Affect Deferral Planning

For participants in nonqualified deferred compensation (NQDC) plans, it's time again to make like an autumn squirrel and decide how much to store for the future.

In November and December, many executives and key employees who participate in NQDC plans must decide how much of next year's salary to defer. Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans (and this year also the outlook for future tax rates under legislation in Congress). The IRS just set the qualified plan limits for 2022.

As explained at our sibling website myNQDC.com, the contribution limits of qualified plans are the major reason for the existence of nonqualified plans: to allow executives and key employees to squirrel away additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan.

The IRS changes in limits from 2021 to 2022 are relatively small. If you've already maxed out your qualified plan contributions for 2021, you will probably do the same in 2022, so you will need NQDC plans to defer any salary and bonus increases you expect in 2022. Also, depending on tax legislation in Congress, there may be higher tax rates in 2022 and/or beyond, increasing the need to defer income.

Contribution type/limit	2021	2022
Compensation allowed in qualified deferral and match calculation	$290,000	$305,000
Elective compensation deferrals	$19,500	$20,500
Catchup contributions for people aged 50 or older	$6,500	$6,500
Total defined contribution limits (employee and employer contributions)	$58,000 + catchup contribution	$61,000 + catchup contribution
Defined benefit plan payout limits	$230,000	$245,000
Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation	$185,000	$200,000
Income threshold defining highly compensated employees for the purposes of nondiscrimination testing; this also applies to the income point where companies can exclude employees from a tax-qualified ESPP	$130,000	$135,000

Set by the Social Security Administration, the Social Security wage cap will rise in 2022 to $147,000, a slight increase from $142,800 in 2021. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $8,853.60 in 2021 and will rise to $9,114 in 2022. Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC. See also our FAQ on the top NQDC-related year-end-planning issues.

Alert: Newly Issued 2020 IRS Qualified Retirement Plan Limits Affect NQDC Participants

Over at our sibling website myNQDC.com, all about nonqualified deferred compensation (NQDC) plans, an important annual development has just dropped for NQDC participants who are starting to think about how much of next year's salary to defer into their plan's piggy bank.

In November and December, many executives and key employees eligible to participate in NQDC plans must decide how much, if any, of next year's salary to defer. Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans. The IRS just set these limits for 2020.

The contribution limits of qualified plans are the major reason for the existence of nonqualified plans: to allow executives and key employees to save additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan. The changes in limits from 2019 to 2020 are slight. If you've already maxed out your qualified plan contributions for 2019, you will probably do the same in 2020, so you will need NQDC plans to defer any salary and bonus increases you expect in 2020.

Contribution type/limit	2019	2020
Compensation allowed in qualified deferral and match calculation	$280,000	$285,000
Elective compensation deferrals	$19,000	$19,500
Catchup contributions for people aged 50 or older	$6,000	$6,500
Total defined contribution limits (employee and employer contributions)	$56,000 + catchup contribution	$57,000 + catchup contribution
Defined benefit plan payout limits	$225,000	$230,000
Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation	$180,000	$185,000
Income threshold defining highly compensated employees for the purposes of nondiscrimination testing; this also applies to the income point where companies can exclude employees from a tax-qualified ESPP	$125,000	$130,000

Set by the Social Security Administration, the Social Security wage cap will rise in 2020 to $137,700, a slight increase from $132,900 in 2019. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $8,239.80 in 2019 and will rise to $8,537.40 in 2020. Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC. See also our FAQ on the top NQDC-related year-end-planning issues.

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Capital Gains Indexing: Tax Cut By Presidential Executive Order?

Capital gains tax affects everyone with employee stock compensation. Anyone who sells shares acquired from equity comp is subject to the tax rules of capital gains and losses.

Now capital gains tax is back in the news in a big way. According to media reports, the Trump White House is seriously considering a presidential executive order which would require the United States Treasury to issue new regulations that index the capital gains cost basis for inflation. That would effectively result in a tax cut—but without the approval of Congress.

While this has been a "sleeper" issue so far, not getting much coverage in the news media or in publications used by many tax professionals, it's a big deal. A tax change by executive order, bypassing the power of the purse in Congress, would be constitutionally controversial. It would have a major impact on the federal budget (see an analysis by the Wharton School at the University of Pennsylvania). The legal challenges against it would be prolonged, complicating its implementation.

How Capital Gains Indexing Would Work

The concept of capital gains indexing has been around for a while. As long ago as 1990, when investors did not have the current preferential long-term capital gains tax rates of 0%, 15%, and 20%, it was mentioned in a report issued by the Congressional Budget Office.

How would indexing work? In brief, the cost basis of an investment is the number you subtract from your sale proceeds to determine the size of your gain (or loss). Capital gains indexing would increase the cost basis of investments, such as stock, for inflation. With indexing, the cost basis would be floating and no longer a fixed number.

Currently, the income trigger points for long-term capital gains tax rates are indexed. If the basis itself were indexed, you would reduce the size of your taxable proceeds at sale, as only the inflation-adjusted capital gain would be taxed.

Example: Your restricted stock unit (RSU) grant vested at $20 per share. Under current tax treatment, that will be the cost basis of those shares whenever you sell them. With capital gains indexing, assuming 2% inflation per year for five years before you then sell the stock, with a sale price of $30 per share your basis would instead be approximately $22 at sale. You would then have $8 in long-term capital gain, compared with a $10 gain under the current tax treatment.

Controversy Over Indexing

The big issue is whether the definition of "cost" in Internal Revenue Code Section 1012 is vague enough to allow for interpretation through new Treasury rules without approval by Congress. Should the Treasury decide it has the authority to make this happen through executive order, it will require detailed regulations on actually how and when the indexing occurs, potentially disrupting many financial-planning and charitable-donation strategies based on its application to different assets. The policy of inflation-indexing capital gains has both its supporters (see Tax Foundation and Americans for Tax Reform) and its critics (see Institute on Taxation and Economic Policy and the Tax Policy Center).

From our experience at myStockOptions.com in developing and updating tax-return-reporting guides for brokerage firms, indexing the cost basis will strain their administrative, reporting, and IT systems. They report to the IRS and brokerage customers the cost basis and other purchase/sale information on Form 1099-B, which is hard enough to get right even when the basis is fixed. The inevitable and lengthy legal challenges to the executive order would also create uncertainty about the actual size of the after-tax gains from any asset sale.

See the Tax Center at myStockOptions.com for detailed information about recent tax changes and their impact on stock compensation.

Employees Must Know These 3 Key Tax Numbers In 2019

Amid their busy lives as the year begins, employees and their financial advisors must remember to consider three key numbers in the tax-law provisions that are annually adjusted for inflation by the IRS and the Social Security Administration. These impact their paychecks and basic tax planning for 2019.

Some of the adjusted tax-code sections are of interest only to super-wealthy executives and other individuals, such as the federal exemption for estate tax ($11.4 million per individual, $22.8 million per married couple in 2019). Others are chiefly matters for corporate benefit-plan administrators. For example, the income definition of “highly compensated employee,” which affects eligibility for employee stock purchase plans (ESPPs) and 401(k) plan non-discrimination testing, rose to $125,000 in 2019.

Below are the top three sets of tax figures that employees should know. They relate to compensation from work involving paycheck withholding, the potential need for estimated taxes, and your retirement savings.

1. Social Security Wage Base

Social Security tax (6.2%) applies to wages up to a maximum amount per year set annually by the Social Security Administration. Income above that threshold is not subject to Social Security tax (by contrast, Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level). In 2019, the Social Security wage cap is $132,900, up slightly from $128,400 in 2018. This means the maximum possible Social Security withholding in 2019 is $8,239.80. Once your income is over that amount, you’ll see 6.2% more in your paycheck!

2. Income-Tax Brackets

The table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate (i.e. the next highest rate from your standard tax bracket). This tells you whether the taxes withheld according to your preference on Form W-4 will cover the total tax you will owe for 2019. To avoid “penalizing” additional income in your mind, be sure you know your effective or average tax rate.

Income Tax Brackets And Rates In 2019

RATE	TAXABLE INCOME (SINGLE)	TAXABLE INCOME (JOINT)
10%	$0 to $9,700	$0 to $19,400
12%	$9,701 to $39,475	$19,401 to $78,950
22%	$39,476 to $84,200	$78,951 to $168,400
24%	$84,201 to $160,725	$168,401 to $321,450
32%	$160,726 to $204,100	$321,451 to $408,200
35%	$204,101 to $510,300	$408,201 to $612,350
37%	$510,301 or more	$612,351 or more

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies use not your W-4 rate but the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly income amounts in excess of $1 million).

As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% may not cover all of the taxes you will owe that on supplemental wage income. In that case, you must either put extra money aside for your 2020 tax return, pay estimated taxes, or adjust your W-4 for your salary withholding to cover the shortfall.

3. Qualified Retirement Plans

In 2019, you can elect to defer up to $19,000 from your paychecks into qualified retirement plans, such as your 401(k). This is a $500 increase over the 2018 limit. The total ceiling for deferrals to defined contribution retirement plans (including any additional part contributed from your employer) rose to $56,000 in 2019, a $1,000 increase. Both of these limits are $6,000 higher if you are 50 or older. The amount of compensation income that can be considered in the calculation for qualified deferrals is $280,000 in 2019.

Want To Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan or other name. For more on these plans, see the website myNQDC.com.

IRS Resources

Here are resources with more details on the many adjusted 2019 tax numbers:

• IRS Rev. Proc. 2018-57 gives inflation adjustments in various income-tax-related provisions.
• IRS Notice 2018-83 and an IRS table give the annual adjustments related to various tax-qualified retirement plans.

Private Company Grants Of Stock Options & RSUs: IRS Guidance Provides Limited Support

Equity compensation in privately held companies is tricky for both employers and employees because the companies’ stock is not publicly traded and is therefore illiquid. Introduced by a complex provision of the Tax Cuts & Jobs Act (“tax reform”), which took effect this year, a new section of the tax code, Section 83(i), seeks to make equity comp more appealing to private companies. It lets them make grants of nonqualified stock options (NQSOs) or restricted stock units (RSUs) in which the recipient can defer income taxes for up to five years from NQSO exercise or RSU vesting as long as the grants meet certain conditions. These are called “qualified equity grants.”

However, the initial reaction by private companies to this new opportunity has been cautious and cool. Before plunging in, many have awaited clarification and guidance from the IRS on the many technical requirements and details of the new grant type. In Notice 2018-97, the IRS finally issued guidance for companies on qualified equity grants, with more to come, but it may do little to enhance the appeal of these grants for smaller startups.

The Tax Problem Congress Wanted To Solve But Only Made More Complicated

While stock options and restricted stock units are popular at startups and other pre-IPO companies, employees cannot sell stock at exercise or vesting, even to pay the taxes owed on the income. The IRS confirmed in regulations issued during 2014 that the tax measurement date (at exercise for options and at vesting for restricted stock) is not delayed by any lack of liquidity or securities law restrictions on resales of stock.

The fact that the tax treatment for stock grants at pre-IPO and large publicly traded companies is identical seems oddly unfair when you consider the vastly differing liquidity situations of private and public company employees. While private companies want to use equity grants to motivate, retain, and create employee-shareholders, they do not want to obligate their employees to pay taxes on shares they cannot sell. Seeking to ease this conundrum, Congress first considered the Empowering Employees Through Stock Ownership Act. That bill eventually transformed into part of the Tax Cuts & Jobs Act. To provide for qualified equity awards, it added Section 83(i) to the Internal Revenue Code.

Qualified Equity Grants: Outline Of New Tax Deferral

Instead of automatically delaying when taxation occurs after employees receive illiquid private company stock as compensation, Section 83(i) imposes elaborate rules on what types of grants qualify, what types of employees qualify for these grants, employee deferral elections, and procedures companies must follow. The table below summarizes some of the main features of the new Section 83(i).

Key Facts For Tax Deferral Of Private Company Stock Grants

Eligible types of stock compensation	NQSOs and RSUs
Tax deferred	Federal income tax
Deferral period	Five years, unless triggered earlier
Election required	83(i) election within 30 days of exercise or vesting
Company requirements	Numerous, including grants to 80% of employees

For more details on this tax code provision, see our related article: Private Company Stock Options And RSUs: 10 Facts To Know About The New Tax-Deferral Opportunity.

Three Topics IRS Guidance Addresses

In Notice 2018-97, the IRS clarifies and creates rules in three areas that are evidently the most pressing for companies.

1. Time requirement for the 80% rule. To make qualified equity grants, the company must issue grants to at least 80% of employees in a single calendar year. The law does not provide for a cumulative basis that considers grants from prior years. Apparently, the IRS felt it had to go with the statutory language.

Potential impact: This makes it more difficult for early-stage startups, as they primarily make new-hire grants, not annual grants that can more easily fit into a calendar year. For example, imagine a 10-employee startup in which everyone gets meaningful grants at hire. Next year, the company hires two more employees, who also get meaningful grants. Although 100% of employees have equity awards, the company made grants to only 20% in that year, and therefore those grants cannot be tax-qualified. Don’t blame the IRS for this outcome until Congress amends the law.

Big private companies, such as the Unicorns (e.g. Uber, Airbnb), along with other large late-stage pre-IPO companies that make broad-based grants, will find it easier to meet the 80% rule. Their grant practices have probably evolved to become more regular, with annual and bonus grants.

2. Tax withholding. Companies must set up a procedure to escrow the deferred shares employees receive at exercise with options or vesting with RSUs. They then use some of the shares to pay the withholding tax that is eventually due after five years or a liquidity event. Employees must agree to this arrangement at the time of their deferral election.

Potential impact: This new requirement, not stated in the new law, addresses company and IRS concerns about how the taxes will be paid. This becomes a big issue if no liquidity event occurs or when ex-employees cannot be located. The approach does add more costs, procedures, and communications to what companies are obligated to implement.

The requirement makes qualified equity grants more appealing to well-established private companies that are likely to go public or get acquired. They have the resources to set up this type of arrangement. Their employees also assume less risk and thus more potential benefit with the deferral, as they are acquiring stock that has demonstrated value and the potential for liquidity within the five-year deferral period.

3. An opt-out: Companies can designate grants that are ineligible for the employee deferral election. They do this by not setting up the share escrow arrangement or not following other conditions for qualified equity grants.

Potential impact: Companies were concerned that they could unintentionally meet the conditions allowing employees to make a deferral election, potentially causing the company to be penalized for not following the new law’s requirements for employee notices and communications. While the IRS guidance clarifies how companies can opt out of the provision, the pressing need for IRS guidance on how to opt out suggests companies are not eager to make these type of stock grants. Early-exercise stock options or vesting conditions that require an IPO or acquisition will probably remain more popular ways to specially structure stock grants at private companies.

For more information about the taxation of stock options and restricted stock/RSUs, see the Tax Center at myStockOptions.com. The website’s section on pre-IPO companies covers topics related to stock grants at private companies.

Shooting For Overtime With Your Tax Return: IRS Filing Extensions, How To Get One, And Stock Comp Planning For 2018

For those who haven't yet filed federal tax returns, it's getting late in the fourth period, but there is still time to beat the IRS buzzer. The deadline for filing tax returns with the IRS for the tax year 2017 is April 17, 2018.

In any tax season, the recognition of income from stock compensation or an employee stock purchase plan can complicate your return. Examples include income from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock. However, as regular readers of this blog will know, this tax season has the potential to be more confusing than most if you sold any stock last year. Issues are especially likely to arise with the cost basis as reported on Form 1099-B and with the tax-return reporting on Form 8949 and Schedule D. For help, including annotated diagrams of Form 8949 and Schedule D, see the special section of myStockOptions.com called Reporting Company Stock Sales.

Can't Beat The Buzzer? IRS Deadline Extensions For Tax Returns

If you need to take the game into overtime, you can get an extension of the federal filing deadline by up to six months. No explanation or signature is needed. You can request an extension in any of three traditional ways: on IRS Form 4868, through a paid tax preparer, or via tax-return software.

Note that an extension for your federal tax return applies only to the filing of your return, not to the tax itself, which you must pay by the original IRS filing deadline.Therefore, if you get an extension you must accurately estimate how much tax you must pay by the 17th. By paying 100%, you avoid interest and penalties; if you can't manage that, you can still avoid the penalty by paying 90%. If you owe additional taxes when you eventually file, you will have to pay interest on the unpaid amount going back to the original April due date.

For more details on extensions to file and the penalties for the late payment of taxes, see the related FAQ at myStockOptions.com.

Looking Ahead: 2018 Income

When your federal and state tax returns are finally done and you're ready to move on with your life, you may want to make projections of your income in 2018. These should be done with the following three planning points in mind.

First, as in the past few years, individuals who expect income of more than $200,000 this year ($250,000 for married joint filers) should consider the additional Medicare taxes on ordinary income and investment income that were introduced by the Affordable Care Act (Obamacare). Despite the failed efforts last year to repeal Obamacare, it and the taxes introduced to fund it are still in effect.

Second, consider the tax changes that took effect in 2018 under the Tax Cuts & Jobs Act, which has provisions that directly and indirectly affect stock compensation. For details on the impact of these changes on planning for stock compensation and company shares, see the related article on myStockOptions.com.

Third, if you expect additional income from stock comp in 2018, and if your withholding rate will be inadequate to cover the taxes you will owe for the full year, you may want to make estimated tax payments, or at least see whether you can adjust your salary withholding. (The withholding rate for supplemental income, such as equity compensation, is 22% up to $1 million during the calendar year and 37% for yearly income in excess of $1 million.) To avoid penalties, be sure you pay the IRS either 90% of your expected tax bill or 100% of this year's taxes (for adjusted gross incomes over $150,000, it is 110%). Penalties are calculated on a quarterly basis, so you must make estimated tax payments in the quarter when you earned the income.

Note: Details of estimated taxes, including the due dates, are discussed in IRS Form 1040-ES, and on myStockOptions.com in the sections NQSOs, ISOs, Restricted Stock, and SARs.

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Register For Our Financial-Planning Conference

We are preparing to hold our first-ever conference, a one-day event: Financial Planning for Public Company Executives & Directors (Monday, June 18, 2018). Taking place in the Boston area, this is a must-attend national conference for financial, tax, and legal advisors working with or wanting to counsel executives, directors, and high-net-worth employees. We have a wonderful group of expert speakers and a comprehensive agenda of sessions on various stock-related and financial-planning topics:

• trends of importance to advisors
• tax, estate, and SEC-related planning challenges
• methods for attracting and advising high-net-worth clients
• case studies and other examples of successful planning strategies

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Taxation Animation: Fun, Engaging Videos At myStockOptions Can Help You Prevent Mistakes On Tax Returns

Reporting stock sales on your tax return has not gotten any easier (or more exciting) this year. However, if there's a way to make learning about accurate tax-return reporting less tedious, we'll try it. In the Tax Center at myStockOptions.com, two animated videos give practical guidance about the reporting of company stock sales on tax returns in an engaging style. The covered topics include IRS Form 1099-B and the cost basis of shares acquired from equity comp, along with the reporting on IRS Form 8949 and Schedule D. These videos offer a quick way to learn the basics of these important points and prevent expensive mistakes on tax returns.

New this tax season is Tax-Return Reporting Of Company Stock Sales: How To Avoid Overpaying Taxes (running time: 8:05). In this video, the tax experts at myStockOptions.com explain:

• the rules for reporting stock sales on your tax return
• major errors to avoid if the shares you sold came from stock options, restricted stock/RSUs, stock appreciation rights, or an employee stock purchase plan
• the "cost basis" of shares acquired from equity compensation
• why it is crucial to understand your cost basis to avoid overpaying your taxes

The video also covers recent modifications of IRS rules, how these changes restricted what brokers can report on Form 1099-B for stock sales, and the related adjustments you must make on your tax return. Included are examples and annotated versions of key IRS forms to show the correct way to report your taxes and prevent costly mistakes. The video ends with key takeaways to remember so that you do not overpay taxes and attract unwanted IRS attention.

Click here to see the video at myStockOptions.com, or watch it right here via our nifty YouTube channel:

In our other tax video, Tax-Return Forms And Reporting Rules For Stock Sales (running time: 8:08) you will learn about:

• the reporting on Form 1099-B, and why the reported cost basis may be wrong or omitted
• how to figure out the right cost basis for your stock sales
• Form 8949 and how to report stock sales on it
• how to interpret Form 1099-B when completing Form 8949
• what to do when the cost basis in Box 3 of Form 1099-B is too low or not given
• totaling the reported stock sales on Schedule D

Please try our videos! They're informative, and each is just eight minutes long.

Like all the content at myStockOptions.com, these videos can be licensed and customized to fit company stock plans. We also have podcasts with audio presentations on tax-return topics. Our video and podcasts complement the helpfully annotated diagrams of Form 8949 and Schedule D that appear in special FAQs in our Tax Center.

Updated Stock Compensation Audit Guide From The IRS Provides Compliance Checklist

To help its examiners, the IRS develops Audit Techniques Guides (ATGs) to provide insights into the issues and accounting methods that are unique to certain industries and types of compensation. While ATGs are designed to provide guidance for IRS employees, they can also reveal tax issues that need special attention from taxpayers, companies, and tax professionals.

In late August, the IRS released an updated version of its ATG for audits involving stock compensation: Equity (Stock) - Based Compensation Audit Techniques Guide, which seems to be a set of marching orders for IRS examiners. Companies, tax professionals, and compensation consultants will want to review it. (The update to the equity comp ATG follows a recent update to the IRS audit guide on nonqualified deferred compensation, issued in June.)

In this blog commentary, we provide an outline of the updated ATG on stock compensation. Parts of the guide summarize and confirm the tax treatment for different types of equity compensation. Other parts raise issues about how the IRS applies and interprets certain IRC sections and IRS regulations. Although we are still absorbing some of the guide, we are eager to publish this outline of it now to present its important points to the many people who follow myStockOptions.com and stock compensation developments.

How The IRS Prepares For Audits

During the initial examination process, a review of the company's SEC filings and the taxpayer's internal documents is a good place to start, recommends the ATG. The review of these documents may help to identify people who have received equity-based compensation, suggests the guide, which gives some tips for examiners (and anyone, really) on how to find the key provisions in SEC filings and company documents.

What IRS Looks For In Stock Transfers And Awards

The ATG lists, with brief explanations, the hot IRS topics that are leading to tax errors in recognizing income, withholding, reporting, and underpayments. Given all the other subjects related to stock compensation that the IRS could have selected, we assume that these are high priorities. In the guide, the IRS tells its auditors to determine whether:

• stock was actually transferred
• stock options were transferred to a related person
• the purchase price was reduced for a note used to acquire employer stock
• elections were punctually made under IRC §83(b) and records verify these timely elections
• a substantial risk of forfeiture exists to delay vesting according to the facts and circumstances
• dividends were paid on restricted stock

For each of these, the IRS explains the issues and then covers ways in which examiners can root out potential tax errors.

What IRS Looks For With Stock Options

In addition to the items listed above, the ATG delves into even greater detail with stock options. The guide tells IRS auditors to determine the type of stock options granted and to then closely examine whether:

• statutory stock options, which in IRS terminology includes ISOs and tax-qualified ESPPs, are following the specific IRC provisions for them, both in their grant terms and in the taxes incurred when shares are sold
• reporting and filing rules were complied with, including those for Form W-2 and those required for ISOs and ESPPs under IRC Section 6039
• appropriate amounts were promptly deposited for the withholding of FICA, FUTA, and federal income tax

The ATG also covers other types of equity-based compensation, instructing its examiners to look at the payout structure of phantom stock plans and of stock appreciation rights (SARs) at exercise. While the guide has information on restricted stock units (RSUs) near the end, this is merely a summary of the tax rules for them and a reminder that RSUs must follow IRC Sections 451 and 409A to avoid taxation at grant.