The NASPP Blog

June 2, 2010

Cost-Basis Reporting: Complicating an Already Confusing Topic

Cost-Basis Reporting: Helpful Information or Disaster Waiting to Happen?
Cost-basis reporting on Form 1099-B will be required for sales of any equity securities acquired after January 1, 2011. This includes sales of shares acquired under stock option, restricted stock/unit, and other stock plans, as well as shares acquired under ESPPs. But the rules apply slightly differently to shares acquired under these plans than for, say, shares acquired via a run-of-the-mill open-market purchase. The end result is likely to be a lot of confusion, a lot of employee inquiries, and, probably, a lot of overpayment of taxes.

Understanding Cost-Basis for Equity Compensation

For shares acquired through an open-market purchase, the cost basis is simply the amount paid for the shares plus any transaction fees (including fees for the sale transaction, if the broker doesn’t report the sale proceeds net of fees on Form 1099-B). But for shares acquired under a stock compensation program, the cost basis also includes any income reported on the employee’s Form W-2 in connection with either the purchase or the sale of the shares.

Maybe You Should Install a Second Phone Line

The proposed regulations on cost-basis reporting, however, only require brokers, et. al., to report the amount paid for the securities as the cost basis on Form 1099-B. Regulations requiring brokers to report the full cost basis won’t be effective until 2013 at the earliest. For stock compensation, this seems like a huge flaw in the reporting requirements.

If, as a stock plan administrator, you’ve been thinking that you don’t need to worry about these rules because it isn’t your job to issue Forms 1099-B, think again! I can only imagine how confusing this will be for employees–who are already pretty confused about how to report stock compensation on Schedule D. Unless you have some top-notch communications about this, you’ll need to be prepared for a lot of employee confusion and inquiries. And this goes for brokers too–employees are just as likely to look to the broker that issued the Form 1099-B for answers as they are to look to their company’s stock plan administrator.

Now I Understand the Additional Tax Revenue

I suspect that many employees will simply report the Form 1099-B cost basis on their Schedule D, not realizing that this is an understated amount. This will cause employees to pay capital gains tax on the amounts that have already been taxed at ordinary income rates. If the sale is less than a year after the stock was acquired (as in the case of a same-day sale exercise), it is a short-term gain, taxed at the same rate as ordinary income. This doubles the federal income tax paid on the transaction–for employees in the highest tax bracket, it could result in taxes paid of more than 80% of the spread.

I’ve been trying to figure out how cost-basis reporting is going to generate so much additional tax revenue, but now I think I understand.

And, if by some miracle, employees do manage to report the correct tax basis on their tax returns, what happens when the cost basis reported on Schedule D doesn’t match the basis reported on Form 1099-B? Currently, if there is a discrepancy in the sale proceeds reported on Schedule D vs. Form 1099-B, this triggers an automatic IRS notice that there is an error on the return. Will the same type of notice be generated if the reported cost-basis amounts don’t match? If so, how will employees explain the discrepancy to IRS auditors–who probably don’t understand cost-basis for equity compensation any better than they do?

Do You Know What Your Brokers Are Doing?

As I understand it, brokers are permitted to go above and beyond the minimum reporting requirements. If they have the full cost-basis information available and are so inclined, brokers can report the full cost basis (amount paid plus amounts included income) on Form 1099-B. Now would be a good time to ask your brokers a few questions about how they plan to comply:

  • What will they report as the cost basis for shares acquired under various types of stock compensation arrangements? Ask specifically about NQSOs, restricted stock/units, ISOs, and ESPPs if you offer all of these arrangements.
  • What sort of communication materials are your brokers going to provide to employees to help them understand the information reported on Form 1099-B and how will this information be provided? Will they actively distribute information to employees or will employees have to ask for it?

Don’t miss the session “IRS Cost Basis Reporting: Are Your Stock Plans Ready?” at the 18th Annual NASPP Conference for more information on this topic.

Thanks to Andrew Schwartz at BNY Mellon Shareowner Services for providing the background information on how the cost-basis reporting requirements apply to stock compensation.  Be sure to check out Andrew’s interview on cost-basis reporting in the upcoming issue of The NASPP Advisor. 

18th Annual NASPP Conference
Don’t miss the 18th Annual NASPP Conference from Sept 20-23 in Chicago. We just posted this year’s program and it is phenomenal–we’ve planned over 40 sessions on critical and timely topics, like cost-basis reporting.  Register for the Conference today.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara