Listed here are Four large tax errors to keep away from after inventory possibility strikes
MoMo Productions | Digital Vision | Getty Images
If you bought or “exercised” company stock options in 2021, financial experts say you need to watch out for tax pitfalls when filing.
A stock option is an opportunity to buy stock in the company that employs you at a specified price, with the potential for profit if the value increases and you decide to sell.
These may include so-called nonqualifying stock options, which add to your annual compensation and increase regular taxes, or incentive stock options, which do not increase income but may trigger other charges.
More from Smart Tax Planning:
Here’s a look at more tax planning news.
“The time to create a tax and exercise plan is before you exercise,” said board-certified financial planner Kristin McKenna, chief executive officer at Darrow Wealth Management in Boston.
But whether you exercised stock options in 2021 with or without a plan, mistakes can still happen at tax time. Here’s how to avoid four of the biggest mistakes.
1. Double counted income
If you exercise non-qualifying stock options, the rebate you receive, or the “spread” – market value at exercise less the price you paid – becomes part of the annual compensation assessed at regular income tax rates and reported on your W-2 .
For example, if you bought 100 shares for $20 and the market value that day was $30, the spread is the market value of $3,000 minus the purchase price of $2,000, adding $1,000 to your compensation.
The spread is aggregated with your salary in Box 1 on your W-2, but it also appears in Box 12, explained Bruce Brumberg, Editor-in-Chief and co-founder of myStockOptions.com.
But since it’s already part of Box 1, you shouldn’t report it separately, he said, or you’ll pay income taxes twice on the same allowance.
While there is a 22% statutory withholding tax if the spread is less than $1 million, that may not be enough.
“There’s a level of protection there,” McKenna said. “But when you’re at $900,000, 22% just isn’t going to do it.”
2. Reporting the wrong tax base
Another common mistake with nonqualifying stock options occurs when reporting the sale. If you sold those assets in 2021, by mid-February your brokerage firm will mail Form 1099-B covering your gain or loss that appears on Form 8949 when you file your tax return.
However, there will be an error in 1099-B for your stock’s basis or purchase price listed in box 1e, Brumberg said, because nonqualifying stock options calculate the basis by adding the spread at exercise to your purchase price.
For example, if you paid $20 and the market value that day was $30, your spread on exercise is $10, which is added to the purchase price of $20 on a $30 basis .
“Sometimes you see on forms [the basis] omitted entirely, or sometimes only the strike price is provided, which is inaccurate,” said Chelsea Ransom-Cooper, a New York-based CFP and managing partner at Zenith Wealth Partners.
However, if you use the $20 basis that may be listed in box 1e of your 1099-B, you pay taxes on an additional $10 per share of earnings. In this scenario, you can fix the error by adjusting your profit or loss on Form 8949 in column g, Brumberg said. You can find out more about this topic here.
3. Ignoring an alternative minimum tax
Incentive stock options, another type of stock-based compensation, do not contribute to annual income. However, the spread at exercise creates an adjustment for what is known as the alternative minimum tax, or AMT, a parallel scheme for higher earners that can cause a higher bill.
“Everyone is always very nervous about AMT,” said Bryan Hasling, CFP and partner at Lodestar Private Asset Management in Alamo, California. “But it’s not so bad if you understand.”
If you exercise incentive stock options and hold your stock, you’ll receive Form 3921 in January and you’ll need to do the calculation to see if you owe AMT, which removes certain depreciation instead of paying regular taxes.
When you owe AMT, you pay taxes up front that you can recoup in future years, Hasling explained. That’s because it creates AMT credits that you can use to offset duties once regular taxes exceed AMT.
Of course, you need to keep track of AMT credits and share the details with your accountant each year. Otherwise they will not be able to verify that you qualify.
“If you don’t tell your accountant, you’ve lost real money,” Hasling added.
4. Lack of organization
If you’ve exercised stock options, it’s important to keep track of exercise prices, market values and tax deductions to compare against the details on your W-2 and 1099-B forms, Ransom-Cooper said.
However, you can now get organized by logging into your stock options account and printing activity reports. You can also see how the numbers match up by checking your year-end payslip. “You can never give too much to an accountant,” she said.
In the future, you can save money by working with an advisor before exercises and tracking every transaction. And you can reduce headaches by saving copies of each confirmation and taking notes on pricing and tax withholdings, Ransom-Cooper said.
“Have it on hand so you can really count on professionals to make sure you’re not overpaying,” she said.