There have been discussions about Employee Stock Purchase Plans (ESPPs) in this forum. In general, most work something like:
- The market price is Y.
- Your company lets you buy it for X, and X<Y so you buy N shares.
- At some point you sell it for Z.
...where X, Y, and Z are all in units of $/share.
In the year you buy it, N * (Y - X) is added to your W-2 and you must pay ordinary income tax on that amount. Because you have now been taxed, your basis for the stock is Y.
When you sell the stock, if Z>Y you have a capital gain of N * (Z - Y) and if Z<Y you have a capital loss of N * (Y - Z). If you sell within a year the capital gain is short term, otherwise it is long term.
For the tax year in which you sell, you get a 1099-B from your broker documenting the calculation above and you pay the appropriate taxes on your capital gain/loss.
Some people had the misfortune of a broker reporting the basis as X instead of Y. This caused people to pay too much capital gain tax if they did not correct the basis and do the correct calculation. But it seems most had the correct information on the 1099-B. Now, however, it seems the IRS wants everyone to have this misfortune.
Starting this year, practically all 1099-B forms for ESPP stock sales will be wrong!At least, that is what I glean from the items below. The first is quoted from a notice I found on our broker's web site (highlighting added). The second has a link to the "final regulations" mentioned in the broker note, and a quote from the pertinent section (highlighting added).
Despite the IRS claim that "an employee will know" he/she is about to pay too much tax, it seems more correct to surmise that many will
overpay because they
will not know.
Or am I missing a thing or more?
On April 18, 2013, the Internal Revenue Service and the U.S. Treasury Department issued final
regulations regarding Basis Reporting by Securities Brokers and Basis Determination for Debt
Instruments and Options. Under the regulations, securities brokers will no longer be able to increase
the cost basis of shares acquired on or after January 1, 2014 to account for the compensation (W-2)
component recognized by the employee.
Summary of the Change
• To comply with the new regulations, as of January 1, 2014 broker provides the discounted purchase
price as cost basis for shares acquired from an employee stock purchase plan regardless of purchase
date. Prior to January 1, 2014 broker increased the cost basis, in some cases, based on the type of
plan.
• broker has adjusted its reporting systems and for shares resulting from an employee stock
purchase plan you will see the lower cost basis reporting on the holdings page as well
as on the realized gain and loss screens. The lower basis will also be displayed on your 2014
participant statements and 2014 Form 1099-B.
• As a result of these changes, you may not be able to rely on the basis information in your 2014 Form
1099-B, and will instead need to refer to your purchase history available online.
• In addition, shares that are transferred to another Financial Institution will be transferred with the
discounted purchase price as the cost basis.
Quote from the pertinent section of the IRS document mentioned above,
http://www.irs.gov/irb/2013-20_IRB/ar07.html:
4. Stock Acquired Through the Exercise of a Compensatory Option
The proposed regulations provided that a broker was permitted, but not required, to increase a customer’s initial basis in stock for income recognized upon the exercise of a compensatory option or the vesting or exercise of other equity-based compensation arrangement. The preamble to the proposed regulations also stated that the IRS might add a field to Form 1099-B to indicate when stock was acquired via the exercise of a compensatory option. In response, commenters asked that there be no change to the Form 1099-B to reflect compensation status or, alternatively, that using the indicator be permitted, but not required. These commenters indicated that compensation information is not accessible to most brokers, and extensive reprogramming for both the underlying database and the reporting process would be required. The commenters also expressed concerns that, in many situations, a broker would have to accept customer-provided information in order to track the compensation-related status.
After consideration of the comments, the Treasury Department and the IRS agree a compensation-related field should not be added to the Form 1099-B. The lack of a mechanism to communicate whether the basis of stock has been adjusted for the exercise of a compensatory option coupled with a system involving discretionary broker adjustments for compensatory options would, however, be unworkable. Therefore, these final regulations provide that brokers are not permitted to adjust basis to account for the exercise of a compensatory option that is granted or acquired on or after January 1, 2014. This approach will eliminate confusion and uncertainty for an employee who has exercised a compensatory option. Under the permissive adjustment rule in the proposed regulations, without an indicator on Form 1099-B, an employee would not necessarily know whether the basis of the stock acquired through the exercise of a compensatory option had been adjusted by a broker to account for any income recognized by the employee due to the option exercise. By prohibiting adjustment by a broker, an employee will know that the basis number reported by the broker only reflects the strike price paid for the stock and that a basis adjustment may be necessary to reflect the full amount paid by the employee.
