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Author: yenomit Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121149  
Subject: Incentive stock: capital or compens? Date: 3/5/1998 11:47 AM
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In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for buying the stock). However, my employer also put down the net profit amount on my W-2 as Deferred Compensation.

Now, obviously I can't look for IRS-sanctioned tax advise here, but can someone tell me if this sounds a bit screwy. I mean, I'm going to pay tax on this money twice.

Any thoughts?

Dave
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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2422 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 11:57 AM
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[[In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's
incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for
buying the stock). However, my employer also put down the net profit amount on my W-2 as
Deferred Compensation.

Now, obviously I can't look for IRS-sanctioned tax advise here, but can someone tell me if this
sounds a bit screwy. I mean, I'm going to pay tax on this money twice.]]

First, I think that you are talking about NON-QUALIFIED stock options as opposed to Incentive Stock Options (ISOs). It may seem like a small distinction to you, but there is a difference.

I have created a post on this issue in the Taxes FAQ area. You might want to check it out.

But beiefly, with NQ options, your basis, or cost for tax purposes, of the shares amounts to:

1. The amount that you paid for the options PLUS
2. The amount of income that was required to be reported on your W-2.

So, since you sold the shares virtually immediately after exercise, you'll find that you most likely have very little (or no) gain or loss on the sale of the shares. But even so, you STILL must compute your basis for tax purposes and report the shares sold on Schedule D.

For additional information on employee stock options (both NQ and ISOs), check out IRS Publication 550 at the IRS web site.

TMF Taxes
Roy

SPECIAL NOTE: I try to answer as many questions as I can each week, and I generally select those that have not been asked before. If you don't get a detailed answer to your question, it is probably because my time is so limited during tax season, or because it has already been asked and answered in this folder in the past, or because it has been discussed in the Taxes Frequently Asked Questions area. In order to visit the Taxes FAQ area, go to the Fool's School area (http://www.fool.com/school.htm) and check out "Other Features" in the list box, OR you can jump directly to the Taxes FAQ area (http://www.fool.com/school/taxes/taxes.htm). Additionally, if any references were made to the IRS Web Site, you can get there by pointing your web browser to (http://www.irs.ustreas.gov)


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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2423 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 12:00 PM
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[[In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's
incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for
buying the stock). However, my employer also put down the net profit amount on my W-2 as
Deferred Compensation.]]

Huh?? Deferred Compensation??

I just went back and re-read your question. While the bargain element of the NQ option is required to be reported to you on your W-2, I have no idea why it is reported to you as "deferred compensation".

You might need to speak with your benefits people for additional clarification. Or perhaps, KAT in Chicagoland (who specializes in these types of transactions) will be kind enough to shed some light on this. Perhaps he has seen something like this in the past. I certainly haven't.

TMF Taxes
Roy

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Author: kkrause Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2430 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 6:03 PM
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I had the same thing happen to me several years ago. I reported it as a purchase and sale same day on Schedule D. Got a nastygram from IRS six months later asking why I did not report it as as income. I wrote a long letter explaining it and heard back three months later that all was forgiven.

At this point, I believe that you can not correct the error that someone else made. Just be ready to do some explaining.

I also was asked why I did not report the 3.76 interest from a saving and loan that was merged, so the moral of the story is that once they find a discprency, they check all W-2's they received against your return. PS- They forgave the few cents i would have owed on the 3.76 in interest.

Not a tax advisor though, Just a schmuck who had the same problem.

Kevin

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Author: yenomit Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2433 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 7:56 PM
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> I had the same thing happen to me several years ago. I reported it as a purchase and sale same day
on Schedule D. Got a nastygram from IRS six months later asking why I did not report it as as
income. I wrote a long letter explaining it and heard back three months later that all was forgiven.

At this point, I believe that you can not correct the error that someone else made. Just be ready to
do some explaining.

Not a tax advisor though, Just a schmuck who had the same problem.
<

Hey, thanks Kevin. A fellow schmuck appreciated it
:)

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Author: yenomit Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2434 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 8:02 PM
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[[In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's
incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for
buying the stock). However, my employer also put down the net profit amount on my W-2 as
Deferred Compensation.]]

Huh?? Deferred Compensation??

I just went back and re-read your question. While the bargain element of the NQ option is required
to be reported to you on your W-2, I have no idea why it is reported to you as "deferred
compensation".

Yea, that's the screwy part. I don't _think_ I should
be getting taxed twice on the whole thing. Thanks for
the info

Dave

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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2438 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 9:46 PM
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<<In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for buying the stock). However, my employer also put down the net profit amount on my W-2 as Deferred Compensation.

Now, obviously I can't look for IRS-sanctioned tax advise here, but can someone tell me if this sounds a bit screwy. I mean, I'm going to pay tax on this money twice.>>

IRS-sanctioned tax advice? Hmmm . . .

Well, I'll sanction most of what Roy said, pausing only to quibble with his assumption that this would be a nonqualified option. Could very well be an incentive stock option -- but cashless exercise involves a disqualifying disposition which causes it to be *treated* in the same manner as a nonqualified option, so what the hey.

The main point is you don't pay tax on the money twice. You report compensation income equal to the "spread" or "bargain element" on the exercise of the option, and you have to pay tax on that. You also report a sale of the stock, but your cost basis includes the amount reported as income on the shares you sold, so you should have (approximately) zero gain or loss.

As to the issue of how this is reported, it appears your employer reported this item in Box 11 of Form W-2, and if so that's incorrect, but in the category of no harm, no foul. Box 11 is for income deferred from a prior year and the instructions for Form W-2 specify that stock option income does not go there. But putting the amount in Box 11, rather than merely including it in Box 1 (which I believe is the correct reporting) does not change your tax situation in any way. The point of Box 11 is not to apply social security tax to deferred compensation that was already subject to social security tax in a prior year.

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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2439 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/5/1998 9:46 PM
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<<In '97, I exercised some of my incentive stock options. The brokerage, who holds the company's incentive stock, sent me a 1099-B for the cashless transaction gross cost (I sold stock to pay for buying the stock). However, my employer also put down the net profit amount on my W-2 as Deferred Compensation.

Now, obviously I can't look for IRS-sanctioned tax advise here, but can someone tell me if this sounds a bit screwy. I mean, I'm going to pay tax on this money twice.>>

IRS-sanctioned tax advice? Hmmm . . .

Well, I'll sanction most of what Roy said, pausing only to quibble with his assumption that this would be a nonqualified option. Could very well be an incentive stock option -- but cashless exercise involves a disqualifying disposition which causes it to be *treated* in the same manner as a nonqualified option, so what the hey.

The main point is you don't pay tax on the money twice. You report compensation income equal to the "spread" or "bargain element" on the exercise of the option, and you have to pay tax on that. You also report a sale of the stock, but your cost basis includes the amount reported as income on the shares you sold, so you should have (approximately) zero gain or loss.

As to the issue of how this is reported, it appears your employer reported this item in Box 11 of Form W-2, and if so that's incorrect, but in the category of no harm, no foul. Box 11 is for income deferred from a prior year and the instructions for Form W-2 specify that stock option income does not go there. But putting the amount in Box 11, rather than merely including it in Box 1 (which I believe is the correct reporting) does not change your tax situation in any way. The point of Box 11 is not to apply social security tax to deferred compensation that was already subject to social security tax in a prior year.

KAT in Chicagoland
www.fairmark.com
Tax Guide for Investors
Now featuring Roth IRA information


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Author: yenomit Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2449 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/6/1998 12:01 PM
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[The main point is you don't pay tax on the money twice. You report compensation income equal to
the "spread" or "bargain element" on the exercise of the option, and you have to pay tax on that.
You also report a sale of the stock, but your cost basis includes the amount reported as income on
the shares you sold, so you should have (approximately) zero gain or loss.

As to the issue of how this is reported, it appears your employer reported this item in Box 11 of
Form W-2, and if so that's incorrect, but in the category of no harm, no foul.]

Well, no. It's under box 14, as an OTH with the Deferred Compensation box checked. The value shown is the cash value of the stock sold minus the options cost (i.e stock's Fair Market Value - option price). The brokerage that holds the stock options and sold it then sent me a 1099B for the total cash Fair Market Value of the stock sold.
So, in essence, my W-2 and 1099B are both reporting the same basic money, which will get me taxed twice.

If I understand the Tax FAQ on Stock Options correctly, since I did a same-day sale (i.e held for 1 second <g>) the stock acts the same whether it was originally ISO or SOP type stock. If so, it sounds like the brokerage firm screwed up by filing a 1099-B, since I received no additional capital gains between the time I purchased and the time I sold the stock.

Gee, I was able to file EZ last year....<g>

Dave

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Author: KATinChicagoland Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2462 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/6/1998 11:01 PM
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<<Well, no. It's under box 14, as an OTH with the Deferred Compensation box checked. The value shown is the cash value of the stock sold minus the options cost (i.e stock's Fair Market Value - option price). The brokerage that holds the stock options and sold it then sent me a 1099B for the total cash Fair Market Value of the stock sold.
So, in essence, my W-2 and 1099B are both reporting the same basic money, which will get me taxed twice.

If I understand the Tax FAQ on Stock Options correctly, since I did a same-day sale (i.e held for 1 second <g>) the stock acts the same whether it was originally ISO or SOP type stock. If so, it sounds like the brokerage firm screwed up by filing a 1099-B, since I received no additional capital gains between the time I purchased and the time I sold the stock.>>

Dave, you're still not understanding us, which is surely not your fault but rather ours for not explaining clearly enough. The main point is that a 1099-B doesn't report *gain* -- it merely reports the amount your received on the sale. The brokerage firm was correct to file the 1099-B, and it *will not* cause you to be taxed twice. Here's an example with some made up numbers.

You exercise an option to buy 50 shares @$40 when the value of the shares is $60. You pay $2,000 to receive stock worth $3,000 and it's sold the same day. You end up with $1,000 in your pocket.

Your employer should report $1,000 of compensation income, and you pay tax on that amount. In addition, the broker sends you a 1099-B showing you sold stock for $3,000. On Schedule D you report that you received $3,000 proceeds from the sale of stock. And you show your basis in the stock as $3,000 (the $2,000 you paid plus the $1,000 that was taxed as compensation). You have zero gain on this part of the transaction and no tax. You're only taxed once, on the $1,000 of compensation. There may be a small variation between the amount reported as income to you and the net sale proceeds, so you may have a small gain or loss, but nothing is taxed twice.

In the category of tax trivia, the "deferred compensation" box on your W-2 shouldn't have anything to do with this, but instead indicates you made an elective deferral to a 401k plan or similar plan.

KAT in Chicagoland
www.fairmark.com
Tax Guide for Investors
Now featuring Roth IRA information


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Author: yenomit Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2488 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/7/1998 9:49 PM
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Kat

[The main point is that a 1099-B doesn't report *gain* -- it merely reports
the amount your received on the sale. The brokerage firm was correct to file the 1099-B, and it
*will not* cause you to be taxed twice.

....


Here's an example with some made up numbers.


Your employer should report $1,000 of compensation income, and you pay tax on that amount. In
addition, the broker sends you a 1099-B showing you sold stock for $3,000. On Schedule D you
report that you received $3,000 proceeds from the sale of stock. And you show your basis in the
stock as $3,000 (the $2,000 you paid plus the $1,000 that was taxed as compensation). You have
zero gain on this part of the transaction and no tax. You're only taxed once, on the $1,000 of
compensation. There may be a small variation between the amount reported as income to you and
the net sale proceeds, so you may have a small gain or loss, but nothing is taxed twice.]

Ok, that makes sense. I think I was thrown because (a)
I've tried using TurboTax for the first time instead of reading the forms and (b) I assume no one _ever_ sends a financial form unless it relates to the IRS <g>.

[ In the category of tax trivia, the "deferred compensation" box on your W-2 shouldn't have anything
to do with this, but instead indicates you made an elective deferral to a 401k plan or similar plan.]

Got it - it must refer to the 401K amount in Box 13; I was confused since I assumed the Deferred Comp box was _under_ Box 14, instead of extended across.

Thanks again

Dave

(Nerz! Now I really do owe all that tax! <g>)




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Author: spaz One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2494 of 121149
Subject: Re: Incentive stock: capital or compens? Date: 3/8/1998 12:01 PM
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<Your employer should report $1,000 of compensation income, and you pay tax on that amount. In
addition, the broker sends you a 1099-B showing you sold stock for $3,000. On Schedule D you
report that you received $3,000 proceeds from the sale of stock. And you show your basis in the
stock as $3,000 (the $2,000 you paid plus the $1,000 that was taxed as compensation). >

This gets me much closer to determining what I need to do about my ESPP plan sale (see thread "espp - qualifing disposition - TTax), however in the espp plan, I am the one that needs to report the compensation, my employer does not. Any idea where I would report this?

Thanks

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