Updated for 2024.
Stock options and stock purchase plans are a popular way for employers to pad an employee’s compensation outside of a paycheck. However, the Internal Revenue Service (IRS) still requires you to report those benefits on your tax return.
To make tax time less stressful, here’s a quick breakdown of some popular employee stock options and plans. Plus, we’ll look at some of the specific tax forms needed for reporting purposes.
At a glance:
- ESPPs allow you to buy company stock at a discount; they are considered ordinary income or capital gain income.
- RSUs are awarded as compensation, taxed as income when they vest, and the value at vesting becomes the adjusted cost basis.
- ISOs come with strict requirements, while NSOs are less restrictive.
- Different tax forms are used to report various kinds of stock compensation.
Employee Stock Purchase Plans (ESPP)
This voluntary program, provided through your employer, allows you to make payroll contributions to purchase company stock at a discount. The discount can be up to 15% lower than the market price.
Generally, there is an offering period in which the employee can make contributions to this program. The stock’s market price for purchase is then determined on the purchase date. At that time, the employee’s contributions are used to purchase stock at a discount on the employee’s behalf.
Based on how long the employee holds the stock, the discount is considered ordinary income and included on Form W-2 by the employer (nonqualifying position). It is considered capital gain income and accounted for at the time of sale (qualifying position).
Your adjusted cost basis for non-qualifying positions is the compensation income reported on Form W-2 plus your acquisition cost.
For qualifying positions, your cost basis is simply the acquisition cost, allowing the discount received to be reported as a capital gain instead of ordinary income.
Restricted Stock Units (RSU)
These stock units are awarded to an employee as a form of compensation. The employee does not receive the stock at the time of the award but has a specific vesting plan outlining when the employee will receive the stock.
When the stock vests, the employee receives the units, and the fair market value (FMV) of the stock received on that date is considered income. Depending on the employer’s stock plan, you may elect to pay taxes on the income when the stock is awarded, at the time the stock vests, or the vesting date.
The amount your employer reported to you as income on Form W-2 at the time the stock vests will then be your adjusted cost basis in these stock units.
Incentive Stock Options (ISO)
The requirements for ISO units are stricter and, in turn, provide more favorable tax treatment.
ISO units must be held for at least one year after the options are exercised (bought). In addition, you cannot sell the shares until at least two years after the options are awarded to you. For these reasons, any discount you receive by purchasing these options is taxed as a long-term capital gain, which yields a lower tax rate than ordinary income.
Nonqualified Stock Options (NSO)
While ISO units are more restrictive, NSO units are more general. These stock options will generate ordinary income and a capital gain/loss.
When these options are granted, they are granted at a predetermined price. This allows the employee to exercise these stock options at that price regardless of the stock’s price on the date the option is exercised.
When the option is exercised, the employee has ordinary income for the difference between the price they pay (grant price) and the fair market value on the date they purchased the stock (exercise price).
Form W-2
Any compensation income received from your employer in the current year is included on Form W-2 in Box 1. If you sold any stock units to cover taxes, this information is included on Form W-2 as well. Review Boxes 12 and 14 as they list any income on Form W-2 related to your employee stock options.
You will receive Form 1099-B in the year you sell the stock units. The form reports any capital gain or loss resulting from the transaction on your tax return.
You should review your investment records to verify the cost basis amount on Form 1099-B. The cost basis on your Form 1099-B is based on information available to your brokerage. If the information available is incomplete, your cost basis amount may be incorrect.
If your cost basis amount on Form 1099-B doesn’t match your adjusted cost basis based on your records, you can enter an adjustment code B in TaxAct®. Similarly, your Form W-2 likely won’t include your cost basis on Form 1099-B. You’ll want to enter an adjustment amount with code B.
If your Form 1099-B is missing a cost basis amount, you must still calculate and report your cost basis on your tax return.
Form 3921
Form 3921 is issued for incentive stock options in the year they are transferred to the employee. It includes the necessary information to properly report the sale of these units when you decide to sell. Save this form with your investment records. Until you sell the units, you don’t have to enter information from Form 3921 into your tax return.
Form 3922
Form 3922 is issued for employee stock options you purchased but do not sell. Since you have not sold the stock, the holding period requirements have not been determined. Therefore, the employer does not include compensation income on your Form W-2 as ordinary income.
Form 3922 is issued to report the income on your tax return when you sell the units. Like Form 3921, save Form 3922 with your investment records.
The bottom line
Understanding the tax implications of your employee stock options and stock purchase plans can be complex, but being informed about the different types — ESPPs, RSUs, ISOs, and NSOs — can help you navigate tax season more smoothly. Make sure to review the appropriate forms, such as Forms W-2, 1099-B, 3921, and 3922, to accurately report your income and investments. By staying organized and informed, you can make the most of your stock compensation while avoiding any unpleasant tax surprises.