The 2023 tax-return season is unlike others in recent memory for employees who have equity compensation, whether stock options, restricted stock units, employee stock purchase plans, and/or and company shares. The impact of the down and volatile markets of 2022 can complicate your tax return.
Another increasingly common issue for tax reporting involves interstate employee mobility and the allocation of your income between states. That issue is on the rise as more employees than ever work remotely in a different state from their employer, whether in one place or as “digital nomads” moving from state to state.
In a recent myStockOptions.com webinar on tax returns that I moderated, three leading financial and tax advisors with expertise in this area presented ideas and tips for preventing costly tax-return errors and handling various issues related to equity comp and stock-sale reporting. This article summarizes some of the key points they made.
Down And Volatile Stock Prices? Consider Tax-Loss Harvesting…
Amid the down and volatile stock markets of 2022, many employees with stock comp have capital losses from selling company stock whose value fell after vesting, exercise, or purchase. On your tax return, you can apply your capital losses to offset your capital gains, thus reducing your taxable capital gains income. After that, you can also net up to $3,000 (for joint filers) of capital losses against ordinary income (e.g. your salary, income from RSU vesting, income from NQSO exercise). Any usused capital losses are carried forward. This is called “tax-loss harvesting.”
Webinar panelist Stephanie Bucko, a CPA and the co-founder of Mana Financial Life Design in Los Angeles, routinely uses this strategy to help reduce her clients’ taxable income on tax returns. “It definitely impacts the strategy. You can cut out a ton of taxes if you’re able to offset gains with losses.” She uses software to capture her clients’ full financial picture and also talks through their history to identify any capital losses that may be available to net against gains.
“It is likely for tax year 2022 that clients will have capital losses on their tax return,” Stephanie concluded. She pointed out that selling loss-makers can be useful not only to harvest the loss but also to diversify out of a concentrated stock position. “This presents an opportunity for clients with concentrated positions to reduce risk without suffering tax consequences. Our recommendation is to review Schedule D for these tax losses.”
Tax-loss harvesting is also pursued by webinar panelist Daniel Zajac, a CFP, Enrolled Agent, and managing partner of Zajac Group (Exton, PA). He noted that the volatile and declining stock prices of 2022 presented opportunities to take advantage of capital losses not only to offset any capital gains in 2022 but also to carry remaining losses forward to future tax years.
“In a year like last year,” Daniel went on, “I think that a lot of advisors were talking to clients about capturing some losses and carrying them forward. For many advisors that’s part of the process at year-end, and it’s funneled through to the tax preparer to be sure it gets accounted for.”
…But Watch Out For Wash Sales
Be aware that there are limits on tax-loss harvesting for those who try to be too clever with it. If you sold loss-generating stock before the end of 2022 for tax-loss harvesting and then repurchased the same stock in January to keep your investment in it, you will run into the “wash sale” rule. This is triggered by a sale of stock at a loss coupled with the repurchase of the same stock within 30 calendar days before or after the sale.
The result? Your capital loss is disallowed on your tax return for that year, with the basis and holding period added to the replacement shares that you purchase.
Most experts believe that option exercises, RSU vestings, and ESPP purchases are “buys” of company stock for tax purposes. You want to watch out for monthly RSU vestings, as these will trigger a wash sale if you have also sold company stock at a loss within 30 days before or after.
Your brokerage firm will usually track and report wash sales by account. However, it may not do this across different accounts that you (and your spouse) have at the firm and at other brokers. Therefore, you and/or your tax-return preparer must consider trading activity in securities across all the accounts you have.
How should you track all of this? “The first thing I try to do is to educate my clients to avoid the issue,” chuckled webinar panelist Dan B. Hodgin, a CPA and the owner of Silicon Valley Tax Group (Campbell, CA). “But obviously that can’t always be accomplished.” First, he said, you calculate the number of shares sold during the year. “Sometimes it looks as if clients have wash sales throughout the year, but by the end of the year they don’t. They’re all netted out. But if they do in fact have wash sales that are going to carry to a future year, you really just have to do a manual calculation. There’s really no other way.”
You report on Schedule D the wash-sale amount, which differs from the Form 1099-B you receive from the broker, Dan explained.
“In a future year, when those shares are sold that have an adjusted basis, you’re going to adjust in the opposite direction. You want to be sure you have full backup for that. In the year when you report the wash sale, the IRS is not going to bother you or question you. They will just see less of a loss, and that’s the end of that. But in the year when you have a bigger loss that shows on the 1099-B for that year, because you are adjusting for those previous wash sales that have now been cleared out, that’s when the IRS is going to have questions.”
Dan observed that many taxpayers haven’t experienced the issue of wash sales amid the rising stock markets of the past 10 years or so. “But with down markets and 80,000 new IRS agents, I’m going to be very careful with wash sales,” he stated. “I’m going to get a full inventory of shares and track those wash sales and the basis outside the brokerage account. If they’re not tracking wash sales on RSUs or ESPPs, then you have to. It’s the only way.”
“What if wash-sale RSU shares were sold in the same calendar year?” asked a webinar attendee. “If you generate a wash sale in February or March and then sell all the shares you have by December, I’m not going to put it in,” replied Dan. “The two are just going to wash each other out. I’m going to report it only if it has a net effect on the tax return at the end of the year.”
For more details on wash sales, see my Forbes.com article 7 Wash Sale Facts To Know Before Selling Stock For Tax Loss Harvesting.
Remote Work And Digital Nomads: Issues With Employee Mobility
Generally, each state you live in determines what income is taxable and when. Many companies report income to and withhold taxes for only the state where you live when restricted stock units (RSUs) vest or when you exercise nonqualified stock options (NQSOs).
However, other states where you lived during the vesting period may contact you later if its tax officials learn of this stock comp income. The state’s tax authorities may seek a proration of your compensation income for your former residence, basing their tax on the part of the vesting period during which you performed services in their state.
The general rule for sourcing and allocating stock comp income is the number of days worked in the state divided by (for RSUs) the number of days between the grant date and the vesting, or (for NQSOs) the number of days between the grant date and either the vesting or exercise date, depending on the state rules.
In the myStockOptions webinar, panelist Dan Hodgin gave some key guidance for mobile employees. “Get a travel history for the current year,” Dan recommended. “Establish a residency history for the duration of the vesting schedule.”
This is important, he explained, because you can’t necessarily trust your Form W-2 on income determination. “Payroll department staff are not tax experts,” he cautioned, “and the complexity of this issue has grown exponentially since remote working became more readily available.”
State reporting of state-sourced wages on Form W-2 can vary, he added. “New York, for example, requires state wages to equal federal wages. Sometimes the year-end paystub can provide a more accurate state breakdown.”
Once you have your records in place, compare your fact pattern to your W-2, Dan advised. “If the W-2 does not match the fact pattern, ask your company to amend it. If you can’t get the company to amend the W-2, adjust the information on the tax return. Make sure you can back up your allocation with a strong fact pattern.”
With that fact pattern documented, you will be ready for any notice from the “aggrieved” state. He also warned employees to “be wary of low- or no-tax states versus high-tax states.”
Additional Tax-Reporting Resources
The 100-minute webinar in which these tax experts spoke is available on demand. For guidance on the tax-return reporting for stock compensation and sales of company shares, including annotated diagrams of Form W-2, Form 8949, Schedule D, Form 3921, and Form 3922, see the myStockOptions Tax Center.