New 1099-B Equity Plan Reporting Rules Will Cause Confusion

Now that people are filing tax returns, the new 1099-B reporting requirements may cause confusion and sometimes overpayment of taxes for recipients of equity awards, including participants in ESPPs. For all shares acquired under any compensatory awards starting January 1, 2014, brokers are required to report the purchase price for shares as the cost basis for tax reporting requirements.

The new rules state, however, that brokers are prohibited from including equity compensation income in the basis calculation. Normally, if an employee recognizes some compensation income on an award and pays ordinary income tax on it, that increases the basis for tax reporting. For instance, say an employee receives an award of 100 stock options at $50 per share. Five years later, they are exercised for $75 per share. The employee pays taxes on $25 per share as compensation income but does not sell the shares until they reach $90. The 1099-B reported cost basis is $50, for a $40 gain, but because the employee already paid income taxes on $25 per share, the true basis is $75 per share.

This can get even more complicated with ESPPs. An employee exercising an ESPP often will have a discount on the price of up to 15%, and that amount is considered ordinary income even if the shares are held for one year after exercise (note that if share prices fall after exercise, the calculations are more complicated). But the basis that is reported will not reflect taxes paid on this portion.

Brokers can go beyond the requirements to report the compensation element, but in comments on the new regulations, brokers said getting that information from the company was often very difficult. Companies offering awards, therefore, need to be very proactive in helping employees understand what taxes they actually owe to avoid employees overpaying capital gains.

San Francisco Chronicle columnist Kathleen Pender has written two excellent articles (here and here) that explain the issues raised by the new rule.