Tech employees can make great money, but they also get hit with one of the worst taxes imaginable.
It is not AMT, State income tax, or anything to do with Capital Gains.
We call it the 'Double Tax' on Stock Compensation.
This sounds crazy, is it legit? Yes, it is legit.
For new clients, this is one of our favorite wins to get right off the bat. We've amended too many tax returns that were hit by the 'Double Tax'.
Have you ever heard someone say this? “I feel like all of my money is going to taxes.”
Well, in some cases they are right.
Who does this Double Tax impact?
This tax primarily affects folks that use DIY tax software, or work with tax professionals who are not well versed in equity compensation.
And even if the tax preparer is somewhat versed, if they have 400 tax returns on their desk there is an increased likelihood that even they overlook it.
And yes, this includes TurboTax despite them previously stating “Regardless of how the broker reports it, we are going to get it right.” It is not a software issue, unfortunately.
Here is how it plays out:
For most tech employees and financial professionals there is some confusion around how stock compensation works.
Unfortunately, the custodians (E-Trade, Fidelity, Schwab) who provide the actual details can lead taxpayers to further confusion with their incomplete reporting on 1099-B tax forms.
If you sell employee stock (ISO, NSO, and even RSUs) that sale will show up in two places.
1) Your W-2
2) The 1099-B from the custodian.
With many tax forms, you can mindlessly input them into tax software, and all is OK.
This is not true for equity compensation.
In many cases, if you report the income in both places, you are double counting the income, thus doubling your tax.
Instead of paying 35% you may pay 70%. Instead of 50% it may be 100%.
The Mechanics:
With stock sales there are two critical numbers. The cost basis and the proceeds.
Cost Basis: How much you PAID for a stock.
Proceeds: How much you RECEIVED from the sale.
The sales proceeds are accurate. The cost basis can be drastically wrong.
If the cost basis is wrong, what do the custodians do?
Do they leave it blank, or put an N/A? Do they just put a "???" or use bright red ink so it stands out?
No, unfortunately not. They either put $0. Or they use only numbers they know, which can be very low. This is not due to incompetence, it is simply due to a law change in 2014.
Herein lies the problem.
If you don't catch this, then you're reporting an artificially low cost-basis. And reporting an artificially high gain.
"But I've imported my 1099 into TurboTax for the last 11 years and it's been fine."
You're right, it probably has been fine.
“So, how do I find my true cost basis number?”
It depends, but it could be in a few places:
1) Company provided records in excel or a PDF.
2) On the bottom of the 1099-B, in the "supplemental data" area.
3) On your W-2 to see how much you're already being taxed on.
Example for a Non-Qualified Stock Option:
Say it's worth $10. And your exercise cost is $1. You perform a same-day exercise and sale. You made $9.
This $9 is taxed as wages and will show up on your W-2.
Since there was a stock sale, it ALSO shows up on your 1099-B as a $9 gain.
A $9 gain in two places could lead to a maximum tax rate of over 100% if reported twice.
In this situation, the cost basis needs to be ADJUSTED up from $1 to $10. An adjustment of $9 since you're already getting taxed on that amount as wage income.
Keep in mind, if the income & sale take place in different tax years it is a bit more difficult to track. You may need to investigate prior year W-2s or company records.
“How do I make this adjustment?”
Don't worry, you don't need to call E-Trade or your employer to fix. This adjustment is simply made on your tax return on Form 8949..
Everything remains as-is, except the cost basis will need to be $10 instead of $1.
The capital gain is then reduced from $9 down to $0.
'Double Tax' = Eliminated.
Other Forms of Equity:
The above example was for a Non-Qualified Stock Option, but this also can impact ISOs (Incentive Stock Options) and RSUs (Restricted Stock Units).
In Closing:
We know a ‘Double Tax’ sounds crazy, but it is legitimate. We've amended too many tax returns that were affected.
We’ve even put this on the radar of other financial professionals who are now notifying their clients and network.
If you’re concerned that you’ve paid too much in taxes, a quick look through old 1099-Bs can give you clues to see if further forensics are in order. Or you can always reach out to a tax professional or financial advisor that specializes in this area.
Keep in mind, there is usually a 3-year window where prior tax returns can be amended.