The NASPP Blog

The upcoming tax season is shaping up to be a confusing one for your plan participants. They will be receiving new bits of information regarding their equity transactions, all intended to be helpful. The problem with information is that it’s only helpful if you can understand it. As your company gears up for your Section 6039 reporting, don’t push cost basis reporting off as an issue that can wait until 2011 year end.

As Barbara pointed out in her June 2^nd blog entry, requirements for cost basis reporting come in phases and 2011 marks the first phase. For regular stock sales, this will be very helpful. For equity compensation, however, this first phase actually provides misleading information. The cost basis that is required to be in Box 3 of the new Form 1099-B is only the purchase price of the shares, not the actual cost basis. While it is permissible for brokers to go above and beyond the requirement ahead of schedule, I doubt that it will be feasible for, especially for sales of ESPP shares, to put processes in place to capture and incorporate the necessary information to report the true cost basis for all sales in 2011.

Tower of Babel

What the communication quagmire boils down to is that employees are receiving an increasing number of communications with numbers that represent some piece of their tax puzzle, but not all the numbers will match or even be relevant. The message to your seasoned employees can be simple and clear: There is absolutely no change in the way you need to report your income or capital gains. This is true for both the Section 6039 information statements that employees may receive for this upcoming tax season as well as the changes to 2011 Forms 1099-B. Your new employees or those who still haven’t fully grasped the concepts behind tax reporting, on the other hand, will need to be given the resources to avoid making costly mistakes.

Double Trouble

Just to review, let’s talk about an NQSO exercise. At exercise, the employee realizes income on the difference between the exercise price and the FMV on the exercise date. For example, if 100 shares of an option were exercised for $10 per share when the FMV is $15 per share, the employee would pay an exercise price of $1,000 and realize ordinary income of $500. The new cost basis for these 100 shares is the exercise price plus the income, which is $1500 or $15 per share.

If the exercise in this example takes place in 2011 and the employee sells 11 shares to cover the taxes due, she or he will receive a Form 1099-B from the broker for the 11 shares showing a cost basis of $10 per share. Leaving the fees and commission on the sale out of the conversation, this means that the employee could easily misunderstand and pay capital gains taxes on that same $5 per share that is reported as income on his or her W-2–effectively paying taxes twice.

The Broker Connection

Brokers are making changes to their back-end systems and the user interfaces to accommodate lot ID for sales of shares. Some brokers already have electronic lot selection for some or all brokerage accounts, but the functionality may not yet apply to shares from employer equity plans. You will want to work closely with your broker(s) to understand what any changes will look like for employees, especially if there will be enhanced modeling features. Get educated on how the broker will determine which lot of shares is being sold through employee accounts and if or how employees can designate specific lot sales when selling online.

Now is also a perfect time to provide information to employees on the acceptable methods for determining cost basis of shares and how to plan for tax filing before they engage in a sale. Many brokers have information and FAQs already available that you can leverage to educate your employees.

Because cost basis reporting is only required for sales of shares that were acquired on or after January 1, 2011, you’ll also want to know what your broker is planning to do about reporting for shares purchased prior to 2011.

Break it Down

If possible, provide your employees with an FAQ that illustrates the cost basis of shares sold from each type of equity award that you offer this year so that next year’s conversation won’t mean starting from scratch. If you need a refresher in any of these, the Conference session, “IRS Cost-Basis Reporting: Are Your Stock Plans Ready?” includes a great list. By working to get employees familiar with the term “cost basis” right now, you help them with their tax reporting for this year, making next year’s conversation easier. If you issue ISOs or have an ESPP, any discussion of cost basis must include a refresher on qualifying vs. disqualifying dispositions, which works perfectly into any plans you have in place for educating employees on the Section 6039 information statements they’ll be receiving.

-Rachel