The NASPP Blog

April 14, 2009

Form 1099-B and Schedule D

With April 15 just a day away, I thought it might be time for a quick refresher on Schedule D.

When employees engage in same-day sale exercises of either ISOs or NQSOs, the compensation/ordinary income for their transaction is reported on their Form W-2 for the year. In most cases, employees also receive Form 1099-B reporting the sale proceeds from their broker. Employees will use both of these forms to complete Schedule D for Form 1040 (the full 1040, no 1040EZ for option exercises) to report the sales of their option shares.

Even more confusing, non-employees (consultants, outside directors, etc.) will get two Forms 1099: a Form 1099-MISC from the company reporting their ordinary income on the exercise and a Form 1099-B from their broker reporting their sale proceeds. 

Know Your Brokers

It’s important to know your brokers’ procedures relating to Form 1099-B, as they can vary from firm to firm.

Brokers can choose to report the sale proceeds net of any transaction fees or exclusive of these fees.  If they report net of fees, employees don’t need to do anything special to report the fees on Schedule D. If the 1099-B doesn’t deduct the fees from the sale proceeds, then employees should add the fees to their cost basis on Schedule D.

Some brokers may not issue a Form 1099-B at all.  Rev. Proc. 2002-50 allows brokers to skip this if they follow certain procedures and you use the sale price to calculate employees’ W-2 income on same-day sale exercises.

What to Report on Schedule D

If the broker issued Forms 1099-B to your employees, then you can be sure the IRS also got a copy of the forms and will be checking employees’ tax returns for Schedule D. Employees who don’t file Schedule D (or whose Schedule D doesn’t match their Form 1099-B) are likely to get an automatic notice from the IRS telling them that they need to report their entire sale proceeds as a capital gain. This is, of course, wrong, but the IRS doesn’t know what the cost basis of the stock is, so they assume all the sale proceeds are taxable (at some point in the future the IRS will know the cost basis because brokers will have to include it on Form 1099-B, but this is still years away). Thus, it’s pretty unnerving for employees to get this notice.   

  • Employees report the sale proceeds indicated on their Form 1099-B in column D of Schedule D. It is critical that the amount reported in column D match what is reported on Form 1099-B; a discrepancy is likely to trigger the automatic notice from the IRS.
  • Employees report their cost basis in the stock in column E of Schedule D. Their cost basis will be their option price plus the W-2 income on their exercise. If they exercised an NQSO, the W-2 income is called out (with code V) in Box 12 of their W-2. If they exercised ISOs, they may need another statement from you that tells them what their W-2 income is (we recommend listing it in Box 14 of their W-2).  If their broker didn’t net out their transaction fees, then employees can add these fees to their cost basis.
  • To figure out their capital gain, employees subtract column E from column D.
  • For same-day sale exercises, this all goes into Part I of Schedule D, which is for short-term capital gains.

No Form 1099-B; No Schedule D?

If the broker takes advantage of Rev. Proc. 2002-50 and doesn’t issue a Form 1099-B for same-day sales, then the IRS won’t receive a report of the sale and won’t be looking for Schedule D.  Employees can still file Schedule D if they want–since you will have used their sale price to determine their W-2 income (a pre-requisite for the broker to not issue Form 1099-B), they’ll have a capital loss in the amount of their transaction fees; some employees may want to claim that loss. But, if employees don’t file Schedule D, the IRS will be none the wiser.

What If Employees Receive Error Notices From the IRS?

If employees receive notices from the IRS that their Schedule D is incorrect or omitted, they simply need to amend their tax return to include Schedule D (completed correctly this time). With same-day sale exercises, there should be little or no capital gain, so employees’ tax liability is unlikely to change and, thus, there shouldn’t be any penalties provided that employees respond within the time specified in the notice.

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– Barbara