September 2023

Your Complete Guide to Employee Stock Options and Tax Reporting Forms

Updated for 2023.

Stock options and stock purchase plans are a popular way for employers to pad an employee’s compensation outside of a paycheck. However, the Internal Revenue Service (IRS) still requires you to report those benefits on your tax return.

To make tax time less stressful, here’s a quick breakdown of some popular employee stock options and plans. Plus, we’ll look at some of the specific tax forms needed for reporting purposes.

At a glance:

ESPPs allow you to buy company stock at a discount; they are considered ordinary income or capital gain income.
RSUs are awarded as compensation, taxed as income when they vest, and the value at vesting becomes the adjusted cost basis.
ISOs come with strict requirements, while NSOs are less restrictive.
Different tax forms are used to report various kinds of stock compensation.

Employee Stock Purchase Plans (ESPP)

This voluntary program, provided through your employer, allows you to make payroll contributions to purchase company stock at a discount. The discount can be up to 15% lower than the market price.

Generally, there is an offering period in which the employee can make contributions to this program. The stock’s market price for purchase is then determined on the purchase date. At that time, the employee’s contributions are used to purchase stock at a discount on the employee’s behalf.

Based on how long the employee holds the stock, the discount is considered ordinary income and included on Form W-2 by the employer (nonqualifying position). It is considered capital gain income and accounted for at the time of sale (qualifying position).

Your adjusted cost basis for non-qualifying positions is the compensation income reported on Form W-2 plus your acquisition cost.

For qualifying positions, your cost basis is simply the acquisition cost, allowing the discount received to be reported as a capital gain instead of ordinary income.

Restricted Stock Units (RSU)

These stock units are awarded to an employee as a form of compensation. The employee does not receive the stock at the time of the award but has a specific vesting plan outlining when the employee will receive the stock.

When the stock vests, the employee receives the units, and the fair market value (FMV) of the stock received on that date is considered income. Depending on the employer’s stock plan, you may elect to pay taxes on the income when the stock is awarded, at the time the stock vests, or the vesting date.

The amount your employer reported to you as income on Form W-2 at the time the stock vests will then be your adjusted cost basis in these stock units.

Incentive Stock Options (ISO)

The requirements for ISO units are stricter and, in turn, provide more favorable tax treatment.

ISO units must be held for at least one year after the options are exercised (bought). In addition, you cannot sell the shares until at least two years after the options are awarded to you. For these reasons, any discount you receive by purchasing these options is taxed as a long-term capital gain, which yields a lower tax rate than ordinary income.

Nonqualified Stock Options (NSO)

While ISO units are more restrictive, NSO units are more general. These stock options will generate ordinary income and a capital gain/loss.

When these options are granted, they are granted at a predetermined price. This allows the employee to exercise these stock options at that price regardless of the stock’s price on the date the option is exercised.

When the option is exercised, the employee has ordinary income for the difference between the price they pay (grant price) and the fair market value on the date they purchased the stock (exercise price).

Form W-2

Any compensation income received from your employer in the current year is included on Form W-2 in Box 1.

If you sold any stock units to cover taxes, this information is included on Form W-2 as well. Review Boxes 12 and 14 as they list any income on Form W-2 related to your employee stock options.

Form 1099-B

You will receive a Form 1099-B in the year you sell the stock units. The form reports any capital gain or loss resulting from the transaction on your tax return.

You should review your investment records to verify the cost basis amount on Form 1099-B. The cost basis on your Form 1099-B is based on information available to your brokerage. If the information available is incomplete, your cost basis amount may be incorrect.

If your cost basis amount on Form 1099-B doesn’t match your adjusted cost basis based on your records, you can enter an adjustment code B in TaxAct®. Similarly, your Form W-2 likely won’t include your cost basis on Form 1099-B. You’ll want to enter an adjustment amount with code B.

If your Form 1099-B is missing a cost basis amount, you must still calculate and report your cost basis on your tax return.

Form 3921

Form 3921 is issued for incentive stock options in the year they are transferred to the employee. It includes the necessary information to properly report the sale of these units when you decide to sell.

Save this form with your investment records. Until you sell the units, you don’t have to enter information from Form 3921 into your tax return.

Form 3922

Form 3922 is issued for employee stock options you purchased but do not sell.

Since you have not sold the stock, the holding period requirements have not been determined. Therefore, the employer does not include compensation income on your Form W-2 as ordinary income.

Form 3922 is issued to report the income on your tax return when you sell the units. Like Form 3921, save Form 3922 with your investment records.

This article is for informational purposes only and not legal or financial advice.

All TaxAct offers, products and services are subject to applicable terms and conditions.

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Reduce Your Taxable Income With a 401(k)

With tax season coming soon, you may be wondering how you can reduce your taxable income. One smart place to start looking is your 401(k) plan.

The 401(k) plan was passed by Congress in 1986 to help employees save money for retirement. Employees can contribute to a retirement account on a pre-tax basis, encouraging them to save more money for the future. Many employers even offer to match employee contributions up to a certain percentage, giving employees even more incentive to sock money away for retirement.

Nowadays, a majority of employers offer some type of 401(k) plan to their employees. In turn, plan participants can take advantage of the many tax advantages a 401(k) provides. Here are a few ways your 401(k) can reduce your taxable income and save you money.

At a glance:

There are different types of tax-deferred 401(k)s.
Contributions are deducted from your paycheck before taxes, lowering your taxable income and resulting in reduced taxes paid overall.
Instead of hardship withdrawals with penalties and taxes, consider 401(k) loans for financial hardships.

Types of tax-deferred 401(k)s

Not all 401(k)s are the same. In fact, there are three different types of 401(k)s for traditional employees.

First, there is the traditional 401(k), which is common among larger employers. Next, there is the SIMPLE 401(k), which is available for companies with fewer than 100 employees. Lastly, there is the Safe Harbor 401(k), which allows employees to take 100% ownership of any employer retirement contributions.

And you don’t have to work for an employer to take advantage of tax benefits from a 401(k). Entrepreneurs, contractors, and freelancers have the option to open a Solo 401(k).

Lowering your taxable income with a 401(k)

So how do 401(k)s provide tax advantages to you? As an employee participating in any tax-deferred 401(k) plan, your retirement contributions are deducted from each paycheck before taxes are taken out. Since 401(k)s are taken out on a pre-tax basis, it lowers your taxable income, resulting in fewer taxes paid overall.

For instance, say you make $40,000 annually through an employer. Let’s assume 25 percent of your take-home pay goes to taxes annually. That results in you paying $10,000 in taxes each year, which in turn reduces your take-home pay to $30,000.

But now you want to start contributing 5% of your pay into your employer-sponsored 401(k) plan. Five percent of a $40,000 annual salary results in $2,000 saved for retirement in a year. Since that $2,000 was deducted pre-tax, your total taxable income lowers to $38,000. At the same 25 percent tax bracket, you now only owe $9,500 in taxes, saving you $500 annually on your tax bill. Plus, you saved an additional $2,000 money for retirement, making that one sweet deal all around.

Save on interest earned from 401(k) accounts

If reducing your taxable income wasn’t enough, by contributing to a 401(k), you also reduce your taxes on the interest earned from your contributions. Unlike money stored in the bank, you don’t have to pay taxes on money earned from your 401(k) investments.

Increase contributions to your employer plan

One of the easiest ways to reduce your taxable income is to contribute more to your retirement account. You can easily do that by adjusting your contribution amount through your paycheck if you are involved in an employer’s 401(k).

Usually, you can simply log in to your retirement account and increase your contributions. You can set your contribution to have a specific amount of each paycheck added to your 401(k) account, or you can have a certain percentage of your paycheck taken out.

Since 401(k) contributions are pre-tax, the more money you put into your 401(k), the more you can reduce your taxable income. By increasing your contributions by just 1%, you can reduce your overall taxable income, all while building your retirement savings even more.

Take a 401(k) loan versus a hardship withdrawal

No matter how prepared you may be, financial hardships do occur. During tough times, many people turn to the money they have saved in their 401(k) accounts. Unfortunately, withdrawing money from your 401(k) before you are age 59 ½ has some expensive consequences. 

In order to take a hardship withdrawal from your 401(k), your financial situation must first meet a specific set of criteria as specified by the IRS. If your request for withdrawal is approved, you must then pay federal and state income tax on the amount taken out of your account. You must also pay a 10% penalty fee for early withdrawal.

Instead of withdrawing money from your retirement account, you can consider taking a 401(k) loan instead. Unlike hardship withdrawals, loans have to be paid back. But 401(k) loans are not taxable, so they aren’t as damaging to your finances as a hardship withdrawal. Not all employer plans allow 401(k) loans, so be sure to check with your company’s 401(k) administrator for all the details.

Withdraw at the right time

Though 401(k) contributions are on a pre-tax basis, that doesn’t mean you get away without ever paying taxes on your savings. You pay taxes when you withdraw your earnings.

While that may sound like a major drawback, you still reap benefits by contributing to a pre-tax account now. As you reach retirement age, your income is most likely going to drop as you stop working. In turn, that puts you into a lower tax bracket than you had when you worked full-time. That means that, as a retiree, the money you take out of your 401(k) is likely to be taxed at a much lower rate.

If you withdraw funds from your 401(k) before age 59 ½, however, you are then subject to a 10% penalty as determined by the IRS. The penalties for early withdrawal are there to encourage participants to continue to build their 401(k) savings at a healthy rate, allowing them to leave the workforce and enjoy retirement.

This article is for informational purposes only and not legal or financial advice.

The post Reduce Your Taxable Income With a 401(k) appeared first on TaxAct Blog.

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Gift Tax: Do I Have to Pay Tax When Someone Gives Me Money?

Updated for tax year 2023.

Surprise — Mom and Dad gave you a nice check! Maybe it’s enough for dinner, or maybe it’s something more substantial.

Either way … are there any tax implications for receiving such a gift?

At a glance:

The gift giver pays any gift tax owed, not the receiver.
You don’t have to report gifts to the IRS unless the amount exceeds $17,000 in 2023.
Any gifts exceeding $17,000 in a year must be reported and contribute to your lifetime exclusion amount.
You can gift up to $12.92 million over your lifetime without paying taxes on the gift (as of 2023).
The IRS adjusts the annual exclusion and lifetime exclusion amounts every so often.

How much is the annual gift tax for 2023?

First, let us put your mind at ease. The total gift amount must be quite substantial before the IRS even takes notice.

For tax year 2023, if the value of the gift is $17,000 or less in a calendar year, it doesn’t even count. The IRS calls this amount the annual gift tax exclusion.

If a married couple makes a gift from joint property, they can each gift up to the annual exclusion. This means Mom and Dad could give you $34,000 in 2022 without worrying about paying any gift tax.

This tax exists to prevent people from giving away their money to avoid paying their income taxes. The gift tax rate fluctuates from 18-40%, depending on the size of the gift.

For instance, if you give someone a gift worth between $20,000 and $40,000, the marginal gift tax rate is 22%. But if you give someone a gift valued between $750,001 and $1,000,000, the marginal gift tax rate would be 39%.

Do I have to pay taxes on a gift?

All gifts can be taxable, but there are many exceptions.

As the recipient of the gift, you generally do not have to pay the gift tax. The person who does the gifting will be the one who files the gift tax return, if necessary, and pay any tax due.

If the donor does not pay the tax, the IRS may collect it from you. However, most donors who can afford to make gifts large enough to be subject to gift taxes can also afford to pay the tax on the gifts.

Do I have to report gifted money as income?

Any gift may be taxable, but the recipient of the gift does not have to pay taxes. The person who gives you the gift needs to file a gift tax return if it’s more than the $17,000 annual exclusion.

How much can you gift without paying income taxes?

In 2023, you can gift up to $17,000 per person without the gift contributing to your lifetime exclusion of $12.92 million (up from $12.06 million in 2022).

Each year, the IRS keeps track of any gifts that exceed the annual gift exclusion amount. Your excess gift amount accumulates until it reaches the lifetime gift tax exclusion.

This lifetime gift exemption allows the gift giver to give more than the annual exclusion. They will need to file a gift tax return for any gifts exceeding the $17,000 annual exclusion, but they will not need to pay gift tax until they have given away over $12.92 million in their lifetime.

Do I need to report a gift on my taxes?

If you receive a gift, you do not need to report it on your taxes. According to the IRS, a gift occurs when you give property (like money) without expecting anything in return.

If you gift someone more than the annual gift tax exclusion amount ($17,000 in 2022), the giver must file Form 709 (a gift tax return). However, that still doesn’t mean they owe gift tax.

Do I have to pay taxes on a $20,000 gift?

You do not need to file a gift tax return or pay gift taxes if your gift is under the annual exclusion amount per person ($17,000 in 2023). If you do exceed that amount, you don’t necessarily need to pay taxes.

This is where the lifetime exclusion comes in — each gift you give contributes to your lifetime exclusion amount, but unless your gifts exceed the lifetime limit, you do not need to pay gift taxes, even when you are required to file a gift tax return.

For example, say someone gives you $20,000 in 2023. The giver must file a gift tax return showing an excess gift of $3,000 ($20,000 – $17,000 exclusion = $3,000). Your total gift amount will also be added to your lifetime exemption.

Gifts not subject to the gift tax

Some transfers of money are never considered taxable gifts. These kinds of transfers are tax-free, no matter the amount.

For purposes of the gift tax, it’s not a gift if:

It’s given to a husband or wife who is a U.S. citizen. Special rules apply to spouses who are not U.S. citizens.
It’s paid directly to an educational or medical institution for someone’s medical expenses or tuition expenses.

What about estate taxes and inheritance taxes?

Many people also have questions about estate and inheritance taxes when discussing the gift tax. While often grouped together, these are actually two different types of tax:

Inheritance tax: This is the tax a beneficiary must pay when inheriting assets from someone who died. There is no federal inheritance tax, but as of tax year 2023, six states impose their own inheritance tax — Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. The tax rates vary depending on the inheritance’s size and the beneficiary’s relationship to the person who died. Spouses (and sometimes children or other descendants) are generally exempt from the inheritance tax.
Estate tax: This is the tax taken out of an estate (cash, real estate, stocks, etc.) upon someone’s death. The federal estate tax only comes into play when the total estate value exceeds $12.92 million (the same as the lifetime gift tax exclusion). Any portion of the assets exceeding this amount is a taxable estate. Some states have their own estate tax as well, and the exclusion amount varies depending on the state.

Gift tax calculator

Estimate your gift taxes owed for 2023 with TaxAct’s gift tax calculator.

Step 1: Select your tax year.
Step 2: Select your filing status.
Step 3: Enter any gifts given before the tax year selected.
Step 4: Enter any gifts given during the tax year selected.

All TaxAct offers, products and services are subject to applicable terms and conditions.

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Itemized Deductions vs. Above-the-Line Deductions

You probably know that claiming income tax deductions reduces your taxable income. But did you know that not all deductions are created equal?

At a glance:

Above-the-line deductions are adjustments to your taxable income, subtracted before AGI calculation. They can be claimed even if you take the standard deduction, offering more flexibility.
Itemized deductions are not available to those who take the standard deduction. These expenses are only deductible if you choose to itemize.
Deciding whether or not to itemize depends on your unique tax situation and which option would save you the most money.

What does above-the-line mean?

Maybe you’ve heard the term “above the line” thrown around in tax conversations. Above-the-line deductions are actually adjustments to your taxable income — they are subtracted from your income before your adjusted gross income (AGI) is calculated for tax purposes.

However, the number of above-the-line deductions you take directly affects the amount and type of “below-the-line” deductions for which you’re eligible. Below-the-line deductions, more commonly known as itemized deductions, include any deduction reported beneath the line for AGI calculation on your tax return.

While both deductions ultimately reduce your taxable income, some can have a more favorable impact on your tax bill than others. In most cases, above-the-line deductions are the better choice. Here’s why.

1. You can take above-the-line deductions even if you don’t itemize

The best part of above-the-line deductions? You can claim them even if you take the standard deduction, a fixed amount based on your tax filing status with the IRS. For tax year 2023, the standard deduction numbers are:

$13,850 for single filers and married filing separately
$20,800 for head of household filers
$27,700 for married couples filing jointly or qualifying surviving spouse (previously qualifying widow/widower)

Each tax season, you have the choice to itemize your deductions or take the standard deduction. Typically, you’d want to choose whichever amount is higher, which tends to be the standard deduction for most taxpayers.

You can claim above-the-line deductions on page two of Schedule 1.

2. Above-the-line deductions reduce your AGI

Your adjusted gross income (AGI) is the amount listed on the bottom line of page one of your income tax return. It includes your total income, including wages, business and rental income, capital gains, unemployment income, and so on. It also factors in any itemized deductions you listed on your Form W-4.

Since above-the-line deductions are adjustments to your income, they can also refer to business deductions and losses. For example, a business expense reduces your net business income, reducing your total income.

What’s so special about my AGI?

Quite a lot! Your adjusted gross income is used for many calculations on your tax return.

For example, you can only deduct medical expenses as itemized deductions to the extent they exceed 7.5 percent of your AGI.

Every dollar that reduces your AGI reduces your taxable income, but it may also help you qualify for other deductions. Various credits are limited by your AGI as well. In some cases, an adjustment may help you qualify for a tax credit or other tax benefits that you would not receive otherwise.

Above-the-line adjustments to claim on your 2023 return

Wondering what above-the-line deductions you might qualify for this year? Check out our list of common deductions you may qualify to claim:

Self-employment deductions

Health insurance deduction
The deductible portion of self-employment taxes (generally 50 percent of the tax)
Contributions to self-employed retirement plans such as SEP, SIMPLE IRA Plans, and qualified plans

Education deductions

Student loan interest paid on a qualified student loan for yourself, your spouse, or your dependent
Educator expenses (i.e., school supplies purchased by a teacher for their classroom)

Travel deductions

Moving expenses for certain members of the Armed Forces

Other possible deductions:

Health Savings Account (HSA) deductions
Any penalties paid on early withdrawal from a savings account before it matures
Write-in adjustments, such as the Archer MSA deduction or jury duty pay you turned over to your employer because your employer paid your salary while you served

To itemize or not to itemize?

Most deductions fit neatly into above-the-line or itemized deductions, and you don’t have to worry about where to deduct them. You’re on your way to knowing how to file taxes like a pro. But sometimes, you do get to choose where to deduct an expense — either as an above-the-line deduction or an itemized deduction. So which type is better?

Let’s look at an example:

You can deduct the real estate tax paid on your home as an itemized deduction. However, if you’re a small business owner, you may qualify to deduct a portion of your real estate tax as a business expense. In most cases, you’re better off taking an expense as a business deduction whenever possible. Not only is it an above-the-line deduction, but it may also reduce the amount of self-employment tax you pay.

Another example is self-employed health insurance. As discussed above, these health insurance premiums can be deducted as an above-the-line deduction or as an itemized deduction. However, if you choose to itemize, you must reduce your total medical expenses (including insurance premiums) by 7.5 percent of your AGI. You must do this before you include medical expenses with your itemized deductions. For this reason, you’ll benefit more by taking the self-employed health insurance deduction as an above-the-line income adjustment if you qualify.

This article is for informational purposes only and not legal or financial advice.

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