Our first discussion of cost-basis reporting was posted back in 2009, yet, here we are, still talking about it half a decade later.
Why Am I Still Blathering On About This?
This is still a topic for discussion because the rules have changed again this year. For any shares acquired on or after January 1, 2014, brokers are no longer allowed to voluntarily include the compensation income recognized in connection with the option or award under which the stock was acquired in the cost basis reported on the Form 1099-B issued for the sale. This means that for any shares employees acquired under their options and awards this year, the cost basis reported on Form 1099-B is likely to be too low. Employees will have to report an adjustment on Form 8949 when they file their tax return to correct their capital gain/loss for the underreported basis.
Let’s Review
When you sell stock, your cost basis in the stock is subtracted from your net sale proceeds to determine what your capital gain or loss is. For shares acquired under stock awards, your cost basis is the amount you paid for the stock, plus any compensation income recognized in connection with the acquisition (in the case of NQSOs and restricted/units) or disposition (in the case of ISOs and ESPPs) of the stock.
Brokers have been required to report a cost basis on Form 1099-B since 2011. Previously, brokers were allowed to voluntarily include the compensation income recognized in connection with the award in the reported cost basis. This was good because it meant that sometimes the basis reported on Form 1099-B was correct, making it easy in those instances for employees to report their sales on Schedule D and calculate the correct capital gain/loss. But it was also bad because there was no way to tell, when looking at Form 1099-B, whether the reported basis included the compensation income or not. The end result was a lot of confusion and possibly a lot of over-reported capital gains.
Where Are We Now
You might think the IRS would fix this problem by making brokers indicate whether the basis reported on Form 1099-B includes the compensation income. But you would be wrong. Instead, the IRS decided that the basis reported on Form 1099-B should only be the purchase price. This way everyone knows what basis is reported on Form 1099-B. It’s the wrong basis in most cases, but at least we know what it is. That’s a step in the right direction, I guess.
To make things more confusing, for shares acquired before January 1, 2014, brokers can still voluntarily include the compensation income in the basis reported on Form 1099-B (and still can’t indicate on the form if they’ve done this). And, for option grants, brokers can treat the grant date as the acquisition date. I think that most brokers are planning to apply the new rules to everything, regardless of when the shares were acquired/option was granted, but you should check with your brokers to verify what they are doing.
What This Means for Employers
Forms 1099-B will be issued around mid-February. You should plan on distributing some educational material to employees to explain this. The NASPP webcast “The New Forms 1099-B Are Coming! Are You Ready?” will provide more information on the topic. In addition, we’ve updated all the sample forms, flow charts, and FAQs in our Cost-Basis Reporting Portal for the new rules and the 2014 forms. New this year, we’ve added Cost Basis Cheat Sheets, featuring flow charts explaining how to calculate the adjusted cost basis for most types of stock awards.
It’s that time of the year again…actually, I wonder how many times during each year we say that…(“it’s that time of the year…time for year-end”, “it’s that time of the year…time for 6039 reporting”, “it’s that time of the year…proxy time”). Ah, but I digress. The time of the year I’m talking about today is “tax time”. I just finished compiling a mountain of paperwork and explanations for my accountant and was painfully reminded of just how much paperwork we do receive in preparation for our tax returns. I started to wonder – are your employees lining up at your doorway with questions? Have your communications been sufficient to anticipate and address their likely questions? In today’s blog I explore some of the key misconceptions that employees develop at tax time when it comes to reporting their stock transactions.
Employee Misconceptions
Thinking that restricted stock unit/awards been reported and taxed based upon the sale of shares. If you don’t believe me, just visit Turbo Tax’s question forums. Employees are out there complaining that the sale has not been properly recorded on their W-2. This points to needing clearer communication about what exactly gets recorded on the W-2, and there the company’s obligation to report stops.
Assuming all cost basis information for stock plan shares is recorded on the new 1099-B. Since this is a fairly new reporting requirement, and the rules only apply to stock that was acquired in 2011 or later, it’s a common possibility that not all transactions will have accurate cost basis information on the 1099-B. Employees need to be able to distinguish between transactions and know exactly what the broker is reporting. The 1099-B originates from the broker, so stock administrators should be aware of how the broker is explaining this to employees. Even though issuers aren’t tasked with preparing these forms, you’re likely to get questions about them. Sometimes a simple factual reminder that “anything before 2011 may not be on there” can go miles to clearing up confusion.
Not understanding which ESPP dispositions are recorded on their Form W-2. In theory employers should be recording both qualified and disqualified dispositions for Section 423 plans on the employee’s W-2. The reality is not all employers report qualified dispositions. The employee will get a Form 3922 from the company for the year of the purchase, and then a 1099-B from the broker for subsequent sales. Those are important pieces of information, but also of importance is the portion of income recorded on the W-2. If employees fail to recognize the W-2 component, they run the risk of paying double taxes.
There are many mistakes and assumptions that employees can make in preparing their tax returns. These misconceptions or misunderstandings can vary by employee level of understanding, advice received from advisers and other factors. Stock administrators can mitigate some of these misconceptions by anticipating common areas of assumption and developing an FAQ to proactively head off or clarify areas of question. You may not be tax advisers, but you can certainly help employees to avoid a mountain of misunderstanding, leading to costly mistakes during tax time. For sample communications and other ideas, visit our Tax Withholding and Reporting Portal.
It’s April already, and in spite of the sneezing and wheezing of spring allergies in full force all around me, I couldn’t help but notice that we’re less than two weeks away from tax filing deadline day. April 17th is just around the corner. (Yes, if you’re late in starting your tax return, it is due on April 17th this year; April 15th falls on a Sunday and April 16th is a holiday in Washington, D.C., so that gives filers until April 17th to file their returns.) I’ve been wondering how stock plan administrators are faring this tax season. With the new Schedule D, 1099-B cost-basis reporting, and additional new IRS forms, I’ve felt certain there would be volumes of employee questions.
Do People Really Procrastinate?
There is an abundance of statistics on taxpayer filing habits; many land near a 40% figure as the number of taxpayers who file their tax returns during the last two weeks before the deadline. When I worked on the issuer side of the industry, I recall planning for those first two weeks in April to be filled with last minute participant questions. So I ask: are the questions pouring in this year? If so, I offer some last minute survival strategies for making it through one of our more complex tax seasons (from an equity compensation perspective, of course!) in recent years.
Have Resources Available to Answer the Phone/Email
Even if you’re sure you’re not going to pass out tax advice; even if you’re certain that the broker can answer all of their 1099-B questions, if you had significant transaction activity resultant from your stock plans in 2011, expect that a fair number of those participants have not yet filed their tax returns and they will emerge at the last minute. There’s an expression that I’ve heard often: “Failure to Plan on Your Part Does Not Constitute an Emergency on My Part.” Well, yes, that’s a fair argument. Yet in reality, we know participants are going to have questions. Rather than taking a stand against procrastination, sometimes it’s better to just accept that these things are going to happen and plan accordingly. Look at your volume of activity during 2011, and if it was minimally significant or more, make sure you have a plan in place for someone to answer that participant call. When up against a deadline, nothing is worse than getting voice mail or sending an unanswered email.
Anticipate, Anticipate, Anticipate!
We’re nearing the end of tax season, so hopefully you’ve already gained some flavor for what participants are asking about this year. It’s been a complex tax reporting season from a stock plan perspective, so anticipating hot button questions and having a ready response will help both sides: you with managing the inquiries, and participants with getting what they need quickly. One great trick I heard about (and tested myself once upon a time) can be applied to your email inbox. You can come up with a list of the top 10 questions that you think participants will email about, and then prepare an “auto reply” that lists the top 10 questions and answers. When the participant emails in a question, they will automatically receive the auto-reply. In many cases, the participant may find their answer in the auto-reply and won’t have to wait for you to respond individually to their email. I would suggest that you still respond, but knowing that in many cases the employee could potentially get the information even faster via the auto reply can go yards in assisting employees during peak periods. Keep in mind you don’t have to necessarily answer “tax” questions; sometimes the employee is just looking for a next step or other resources. Something as simple as a question/answer that addresses where they can find more information on a particular topic can be helpful.
I wish you all smooth sailing through the last couple weeks of tax season.
Since cost-basis data won’t show up on Forms 1099-B until January 2012, this probably seems like something you don’t need to worry about right now. But the data you are transmitting to your brokers beginning this January could impact what is reported on Forms 1099-B next year. In light of this, I have four questions you should ask your brokers now about their plans for compliance with the cost-basis reporting requirements.
1. What is the broker planning to report as the cost-basis for shares acquired pursuant to NQSOs? Brokers are only required to report the purchase price as the cost basis but can voluntarily report the full cost basis. More importantly, are your brokers looking to you to provide the cost basis? If so, perhaps you can avoid some of the mess (and potential for employees to double tax themselves) that Rachel Murillo describes in her Nov. 18 blog entry “Paving the Way for Cost-Basis Reporting Now,” by providing the full cost-basis (price + income recognized), so that the correct basis is reported on Forms 1099-B in 2012. This could be a life-saver for your employees in terms of getting their tax returns correct and for you (and your broker) in terms of the amount of employee education necessary and inquiries that have to be fielded.
2. Ditto for shares issued under restricted stock units and awards. These are considered non-covered securities, so brokers don’t have to report any cost-basis data for them at all, but as with NQSOs, brokers can voluntarily report. Having that data on Form 1099-B could be a big help for employees–if it is correct, of course. If you provide your brokers with the correct cost basis for shares issued under awards, will they report it on Form 1099-B for your employees?
3. Ditto for shares acquired under ISOs and ESPPs. Here, however, things are more complicated because employees often recognize ordinary income at the time of sale, resulting in a stepped up basis that isn’t known until the sale occurs. In some cases, it is literally impossible for you to pass the correct basis to your brokers at the time the shares are acquired. But, in other cases, you might be able to make an educated guess. What makes the most sense to pass as the cost basis? For ESPPs, the FMV at purchase would be the right basis if employees engage in disqualifying dispositions but will be wrong for qualifying dispositions. But, the purchase price is almost always wrong, for both qualifying and disqualifying dispositions (the only time it is the correct basis is for qualifying dispositions where the shares are sold at a loss). For ISOs, FMV at exercise will be the right basis for disqualifying dispositions only if the shares are sold at a price higher than this amount. For qualifying dispositions of ISOs, the exercise price is the correct basis. Where does this leave you in terms of the data you pass to your brokers–now would be a good time to ask, before you start transmitting all this data.
4. How should you transmit this data to your brokers? I understand from the recent Stock & Option Solutions webcast, “Cost Basis Confusion: What Do the New Regulations Mean for Stock Plan Professionals?,” presented by Elizabeth Dodge of SOS and Andrew Schwartz of BNY Mellon Shareowner Services, that issuers may be able to use the DTCC’s Cost Basis Reporting Service (CBRS) to transmit cost-basis data for shares acquired through stock plans. Do your brokers want you to use this service and, if yes, how will you get training on it? If no, what method will you use to transmit this data to them?
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Just in the nick of time, the IRS has released the final regulations for cost-basis reporting on Form 1099-B, the first phase of which goes into effect for stock sales occurring on or after January 1, 2011. Thanks to Andrew Schwartz of BNY Mellon Shareowner Services for providing the NASPP with an alert explaining how the regulations apply to stock compensation.
Final Regulations on Cost-Basis Reporting Andrew’s alert covers the key impacts to stock compensation in just two pages, but for those of you that still don’t have time to read it, I provide a few highlights below.
What the…?
Hopefully this hasn’t caught you by surprise, but, in case it has, here’s a refresher. The Economic Stabilization Act of 2009, as a revenue-raising measure, requires brokers to include cost-basis information on any Forms 1099-B reporting sales of securities (stock, options, etc.)–see our earlier alert “Cost Basis Reporting to Impact Stock Plans.” The requirement is phased in over several years; the first phase, which applies to sales of stock, is effective beginning in 2011.
If you are wondering how this will raise revenue, given that the most common mistake employees make when reporting stock sales on their tax returns is to underreport their basis, so was I. That is until I realized that the way the requirements are phased in for stock compensation is actually likely to increase the likelihood that employees will underreport their basis, at least for the first few years. See my June 2, 2010 blog entry, “Cost-Basis Reporting: Complicating an Already Confusing Topic.”
The Final Regulations
Under the final regulations, as under the proposed regulations, cost basis will have to be reported for any sales of stock acquired on or after January 1, 2011. This includes stock acquired through option and SAR exercises, ESPPs, and restricted stock and unit awards. The final regulations carve out an exception for stock that isn’t acquired “for cash.” For our purposes, this includes restricted stock and unit arrangements and also most likely SSARs, because employees do not pay cash to acquire shares under those types of awards. For stock acquired under options and ESPPs, where employees are required to pay for the stock, the broker must report a cost basis at least equal to the amount the employee paid for the stock (the cost basis also includes any ordinary income recognized in connection with the stock, but brokers aren’t required to include this in the cost basis until 2013–hence the likelihood for underreporting).
Unfortunately, the regulations don’t do much to address the complications involved in reporting the cost basis for shares acquired under an ISO or ESPP, which often can’t be fully calculated until the shares have actually been sold.
Why Do You Care (If You Aren’t a Broker)?
I know that it feels like this is something that only applies to brokers but the fact is that these requirements are likely to have an impact on stock plan administration, from additional data that your brokers and transfer agents are going to need from you, to employee confusion, to higher fees that brokers and transfer agents are charging to pay for the additional infrastructure necessary to fulfill the reporting requirements. If you haven’t yet discussed these regulations with your brokers (and transfer agents, this implicates them as well), now is the time to have that conversation.
Conference Audio Available Andrew moderated a great session on this topic at the 18th Annual NASPP Conference, “IRS Cost-Basis Reporting: Are Your Stock Plans Ready?” If you missed it and want to know more about cost-basis reporting, you can purchase the recorded audio for this and any other Conference sessions in downloadable MP3 format. Purchase just the session(s) you want or save by purchasing a package of sessions.
Free Conference Session Audio If You Renew by Dec 31 All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free!
Join Now and Get Three Months Free and Free Conference Session Audio! If you aren’t currently an NASPP member, now is the time to become one! Join the NASPP for 2011 and you’ll get the rest of 2010 for free. If that’s not enough, you’ll also get the audio for one NASPP Conference session for free. Tell all your friends!
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.