Here are 4 big tax mistakes to avoid after stock option moves

If you bought or “exercised” company stock options in 2021, you need to watch for tax pitfalls when filing, according to financial experts. 

A stock option is the chance to buy stock in the company that employs you at a specific price, with profit potential if the value increases and you decide to sell.

These may include so-called non-qualified stock options, adding to your annual compensation and hiking regular taxes, or incentive stock options, which don’t boost income but may trigger other levies. 

“The time to make a plan about taxes and exercises is before exercise,” said certified financial planner Kristin McKenna, managing director at Darrow Wealth Management in Boston.

But whether you exercised stock options in 2021 with or without a plan, mistakes can still happen at tax time. Here’s how to dodge four of the biggest errors. 

When you exercise non-qualified stock options, the discount you receive or the “spread” — market value at exercise minus the price you paid — becomes part of annual compensation, levied at regular income tax rates and reported on your W-2.

For example, if you bought 100 shares for $20 and the market value that day was $30, the spread is the $3,000 market value minus the $2,000 purchase price, adding $1,000 to your compensation.  

The spread is lumped into box 1 on your W-2 with your wages, but it will also show in box 12, explained Bruce Brumberg, editor-in-chief and co-founder of myStockOptions.com.

However, since it’s already part of box 1, you shouldn’t report it separately, he said, or you’ll pay income taxes on the same compensation twice.

While there’s a statutory tax withholding of 22% if the spread is less than $1 million, it may not be enough.

“There is some level of protection there,” McKenna said. “But if you’re at $900,000, 22% is simply not going to cut it.”

Another common mistake with non-qualified stock options happens when reporting the sale. If you sold these assets in 2021, your brokerage company will send Form 1099-B by mid-February, covering your profit or loss, which goes on Form 8949 when filing your return. 

However, there will be an error on 1099-B for your stock’s basis, or purchase price, listed in box 1e, Brumberg said, because non-qualified stock options calculate basis by adding the spread at exercise to your purchase price.

For example, if you paid $20 and the market value that day was $30, your spread at exercise is $10, which gets added to the $20 purchase price for a basis of $30.   

“Sometimes you’ll see on forms [the basis] is completely omitted or sometimes only putting the exercise price, which is inaccurate,” said Chelsea Ransom-Cooper, a New York-based CFP and managing partner at Zenith Wealth Partners.

However, if you use the $20 basis, which may be listed in box 1e of your 1099-B, you’ll be paying taxes on an extra gain of $10 per share. In that scenario, you can fix the mistake by adjusting your profit or loss on Form 8949 in column g, Brumberg said. You can learn more about this issue here. 

Incentive stock options, another type of equity-based compensation, won’t add to yearly income. However, the spread at exercise creates an adjustment for the so-called alternative minimum tax, or AMT, a parallel system for higher earners, that may cause a bigger bill.

“Everyone is always really nervous about AMT,” said Bryan Hasling, CFP and partner at Lodestar Private Asset Management in Alamo, California. “But it’s not so bad if you understand it.”

If you exercise incentive stock options and hold your shares, you’ll receive Form 3921 in January, and you have to run the calculation to see if you owe AMT, which removes certain write-offs, instead of paying regular taxes. 

When you owe AMT, you’re prepaying taxes that you can recoup in future years, Hasling explained. That’s because it creates AMT credits that you can use to offset levies once regular taxes exceed AMT.

Of course, you’ll need to keep track of AMT credits and share the details with your tax professional each year. Otherwise, they can’t check to see if you qualify.

“If you don’t tell your accountant, you’ve lost out on real money,” Hasling added.

If you’ve exercised stock options, it’s critical to keep track of exercise prices, market values and tax withholdings to compare with details on your W-2 and 1099-B forms, Ransom-Cooper said.

However, you can get organized now by logging into your stock options account and printing activity reports. You may also see how the numbers align by reviewing your year-end pay stub. “You can never give a tax professional too much,” she said.

In the future, you may save money by working with an advisor prior to exercises and tracking each transaction. And you can reduce headaches by saving copies of each confirmation and making notes about prices and tax withholdings, Ransom-Cooper said.     

“Have it ready to go so you can really lean on professionals to make sure that you’re not overpaying,” she said.