Year-End Tax Reporting Questions Answered – Equity Compensation

As the year draws to a close, stock plan administrators face the critical task of navigating year-end tax reporting. Proper reporting of equity compensation is essential for compliance with IRS regulations, ensuring employees and other stakeholders have accurate tax documents. This guide provides clear answers to common questions surrounding tax reporting for equity compensation, including restricted stock units, stock options, and employee stock purchase plans.

Restricted Stock Units

When Are RSUs Taxed?

RSUs are subject to FICA taxes (Social Security and Medicare) upon vesting. Federal income taxes apply at the time of payout, when the shares are delivered to the employee. If shares are delivered at vesting, both FICA and income taxes are assessed simultaneously.

How Should RSUs Be Reported on Form W-2?

Income from vested RSUs is included in:

• Box 1: Wages, tips, and other compensation.
• Box 3: Social Security wages (up to the annual limit).
• Box 5: Medicare wages and tips.
• Boxes 16 and 18: State and local wages, if applicable.

Taxes withheld are aggregated with other withholdings and reported in Boxes 2, 4, and 6 for federal, Social Security, and Medicare taxes, respectively​​.

What About Deferred Payouts?

Even if RSU payouts are deferred, Social Security and Medicare taxes are applied at vesting, while income tax is deferred until the year of payout​.

Special Situations for RSUs

• Death: If an employee dies, final income is reported on Form W-2, while the estate or beneficiaries receive a Form 1099-MISC​.
• Retirement: RSUs that vest upon retirement are taxed when the employee becomes retirement-eligible.

Restricted Stock

What Is Restricted Stock?

Restricted stock differs from RSUs as employees own the stock at grant, though restrictions (e.g. vesting conditions) apply.

What Is a Section 83(b) Election?

Employees can file a Section 83(b) election to pay taxes on the FMV of the stock at the time of grant, rather than at vesting. This shifts taxation forward, potentially reducing tax liability if the stock does appreciate significantly​​.

How Is Restricted Stock Reported?

Without an 83(b) election:

• Taxable income is reported upon vesting on Form W-2 in the same manner as RSUs.

With an 83(b) election:

• FMV at grant is reported as wages on Form W-2. Dividends during the restricted period are treated as dividend income and reported on Form 1099-DIV​.

Stock Options

How Are Nonqualified Stock Options Taxed?

NQSOs are taxed at exercise, with the spread between the exercise price and FMV treated as ordinary income. This income is reported on:

• Form W-2: For employees, it appears in Boxes 1, 3, 5, and Box 12 (Code V).
• Form 1099-NEC: For nonemployees, income is reported as compensation​​.

What About Incentive Stock Options (ISOs)?

ISOs are not taxed at exercise but may trigger alternative minimum tax (AMT). Disqualifying dispositions (e.g. selling the stock within one year of exercise or two years of grant) are reported as income on Form W-2​​.

Dividends and Dividend Equivalents

How Are Dividends on RSUs and Restricted Stock Treated?

• RSUs: Dividend equivalents are treated as wages and reported on Form W-2.
• Restricted Stock:
• Without a Section 83(b) election: Dividends are treated as ordinary income and reported on Form W-2.
• With a Section 83(b) election: Dividends are reported as dividend income on Form 1099-DIV​​.

Employee Stock Purchase Plans

What Are the Reporting Rules for Qualified ESPPs?

Qualified ESPPs provide favorable tax treatment, but employers are required to report income regardless of how and when shares are sold. Reporting obligations include:

• Disqualifying Disposition: If shares are sold within two years of the grant date or one year of the purchase date, this is a disqualifying disposition. The employer must report the compensation income in Box 1 of the employee’s Form W-2​​.
• Qualifying Disposition: Even if the shares are sold after meeting the holding period requirements, the employer must report the ordinary income element on Form W-2, Box 1. Additional gain, if any, is taxed as a long-term capital gain by the employee and is not reported by the employer​​.
• Form 3922: Employers must file Form 3922 for the first transfer of legal title to shares acquired under a qualified ESPP. The form includes details such as the grant date, purchase price, and FMV at purchase, ensuring compliance with IRS rules​​.

How Are Nonqualified ESPPs Taxed?

Nonqualified ESPPs are taxed at purchase, with no holding period requirements. The discount provided to employees is treated as ordinary income and reported as wages on Form W-2, Box 1. Employers must withhold applicable income and payroll taxes at the time of purchase​​.

Stock Appreciation Rights

When Are SARs Taxed?

SARs are taxed at exercise. The FMV of the shares or cash received is treated as ordinary income and reported similarly to NQSOs on Form W-2​.

Best Practices for Year-End Reporting

For Administrators

1. Verify Taxable Events: Ensure all equity grants, exercises, vesting, and dividend payments are correctly recorded for tax purposes.
2. Cross-Check Forms: Confirm alignment of Forms W-2 and 1099 with payroll records.

For Employees and Consultants

1. Review Tax Forms: Ensure all reported income from equity compensation is accurate.
2. Consult Professionals: Work with tax advisors to understand the implications of retirement, deferred payouts, or disqualifying dispositions.

NASPP Resources: Guide to Tax Reporting for Equity Plans

Key questions this on demand webinar will answer:

• What goes on Form W-2 for stock plan transactions?
• When should you use Form 1099?
• What are the deadlines for reporting income and taxes withheld for 2024?
• What’s needed for Section 6039 reporting?