Tax Season 2023: What You Must Know About Reporting Rules
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Ready or not, tax-return reporting has changed yet again for the 2023 tax-return season (income received in 2022), though this time the modifications are relatively slight. Meanwhile, the impact of the 2018 changes in tax rates and brackets continues. For employees with income from stock compensation or sales of company stock, the discussion below explains what you need to know about tax returns for the 2022 tax year.
Alert: The IRS routinely postpones the filing due date for taxpayers in areas affected by natural disasters. You can find out whether you qualify for a postponement in the IRS website section Tax Relief In Disaster Situations. For most of California, the April 18 due date for 2022 tax returns has been extended to May 15, 2023.
IRS Form 1040 remains at 38 lines for the 2022 tax year. However, while the length of Form 1040 hasn't changed, the IRS has modified some of the "schedules" that funnel information to Form 1040. For example, Schedule 1 ("Additional Income and Adjustments to Income") of Form 1040 is where you should enter (under "Other Income") the amount of any stock compensation you earned as an employee that was omitted from your Form W-2. This year, the line for entering stock option income has changed.
Below are key aspects of the Form 1040 tax return, its associated schedules and forms, and more details on changes for the 2023 tax season.
Stock compensation, along with salary income reported in Box 1 of Form W-2, is entered on Line 1a of Form 1040. If you are filing a joint return with your spouse, you include your spouse's W-2 income with yours. One of the changes in the 2022 Form 1040 is that the previous Line 1, where you used to report W-2 income, is now broken out into Lines 1a through 1z.
If you sold shares during the 2022 tax year, you enter each sale on Form 8949 and report the total on Schedule D. You then report that Schedule D total on Line 7 of Form 1040.
A concern for anyone with incentive stock options (ISOs), the AMT is calculated on Form 6251. The spread at ISO exercise is reported on Line 2i if the stock was not sold during the calendar year of exercise.
If the ISO stock that triggered the AMT was sold, the difference from the ordinary tax is reported on Line 2k.
Schedule 2 ("Additional Taxes") of Form 1040 has dedicated lines for amounts coming from the tax forms for the alternative miniumum tax (AMT), the Additional Medicare Tax on compensation income, and the Net Investment Income Tax (e.g. on capital gains and dividends). You enter your Form 6251 calculation on Line 1 of Schedule 2. You attach Form 6251 to Schedule 2. The totals from Part I of Schedule 2 go into Line 17 on Form 1040.
The AMT credit that is generated for an ISO exercise that triggers the AMT is recouped through Form 8801, as it was in the past. Schedule 3 ("Additional Credits and Payments") of Form 1040 has a specific line for any credit for prior minimum tax. This applies to anyone with incentive stock options (ISOs) who has triggered the alternative minimum tax (AMT). The amount from Line 25 of Form 8801 goes into Schedule 3 on Line 6b ("Credit for prior year minimum tax") of Part I.
The totals from Part I of Schedule 3 go into Line 20 of Form 1040.
If your company does not report your employee stock compensation income on Form W-2, the revised Schedule 1 for the 2022 tax year indicates that the amount goes in the "Other Income" section on Line 8k ("Stock Options"). Note that this has changed (last year it was Line 8j).
The list of items "a" through "u" (plus "z") under "Other Income" on Schedule 1 is relatively new (previously, taxpayers listed the type of other income and the amount, or put the details in a supplemental attachment). The total for "Additional Income" from Part I of Schedule 1 goes into Line 8 of Form 1040.
Alert: The IRS expects you to report and pay tax on income mistakenly left off your Form W-2. An error by your employer does not release you from that obligation.
In the instructions for Form 1040 (pages 83–84), the IRS has made it clear the section "Other Income" on Schedule 1 is where to put any employee stock option income that is not on your Form W-2 and is therefore not reported on Line 1 of Form 1040:
Line 8k—Stock options. Enter on line 8k any income from the exercise of stock options not otherwise reported on Form 1040 or 1040-SR, line 1h.
Alert: The instructions also clarify that "Other Income" is not where you report nonemployee compensation appearing on Form 1099-NEC.
Before this development, some tax experts thought this "Other Income" category was not for compensation-related income (only for non-wage income). Instead, they believed taxpayers needed to add the unreported W-2 income to wages reported on Line 1 of Form 1040. However, a non-match of W-2 Box 1 and Form 1040 Line 1 can raise red flag with IRS computers. According to the revised Schedule 1 and instructions, the proper reporting is on Schedule 1, assuming your company does not send you a corrected W-2.
Unresolved issues with this change in Schedule 1 include the question of how broadly to read the IRS instructions. It can be assumed to apply to all stock options, and probably ESPPs too, as the IRS often uses the term exercise for purchase. However, the instructions are not clear about how to handle restricted stock/RSUs. A narrow reading of the instructions for "income from the exercise of stock options" would have it apply only to nonqualified stock options and nonqualified ESPPs. That's because for restricted stock/RSUs it is the vesting that triggers the taxable event, and with ISOs and Section 423/tax-qualified ESPPs it is the sale, not the exercise/purchase.
If you are not certain that all equity compensation left off the W-2 goes on Line 8k, then it can fit into Line 8z ("Other Income. List type and amount").
The reporting for nonemployees would not be on the W-2, as explained in the discussion of Form 1099-NEC below.
For employees, tax withholding occurs at NQSO exercise or restricted stock/RSU vesting, and the income appears on Form W-2. For nonemployees, such as consultants and directors, there is no withholding. For them, the income from exercise or vesting appears on IRS Form 1099-NEC ("Nonemployee Compensation") as self-employment income. (Before 2020, it was Form 1099-MISC.)
The income is shown in Boxes 1 and 7 of Form 1099-NEC. You then report that income on Schedule C of your Form 1040 tax return. The IRS instructions for Schedule 1 (see the discussion above) make it clear that this income does not go under "Other Income" on Schedule 1 or on Line 1a of Form 1040.
As this is self-employment income, you also need to calculate on Schedule SE any Social Security and Medicare taxes that you owe.
The flat rate for federal supplemental withholding that applies to stock compensation may not cover the actual taxes you owe according to your marginal tax rate. You may have paid estimated taxes because of income from restricted stock/RSU vesting, an NQSO exercise, an ISO exercise/sale, or an ESPP purchase/sale. On the 2022 Form 1040, estimated tax payments are reported on Line 26.
An additional 3.8% tax applies on top of the usual capital gains tax for people with yearly modified adjusted gross income (MAGI) of more than $200,000 (more than $250,000 for married joint filers). The tax is based on the lesser of either (1) the amount your MAGI exceeds this threshold or (2) your net investment income. You both pay this tax and file IRS Form 8960 with your annual tax return.
For taxpayers with high incomes, the Medicare tax also rose under the Affordable Care Act. The rate increased from 1.45% to 2.35%. Regardless of your tax-filing status, companies must withhold the tax on compensation paid in excess of $200,000 during a calendar year (e.g. it doesn't matter whether you are married and your combined joint income with your spouse is under $250,000). After the Additional Medicare Tax has been withheld, you must file IRS Form 8959 with your tax return, both to ensure enough tax has been paid and to see whether you are eligible for a refund or a credit. For more on these taxes, which are not indexed for inflation, see a related FAQ.
On Schedule 2, these taxes are now reported on their own lines. Line 11 ("Additional Medicare Tax") is for the tax from Form 8959, Additional Medicare Tax. Line 12 ("Net Investment Income Tax") is for the tax from Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts.
Rules For Cost-Basis Reporting
For stock sales, there is no change in the IRS rules on how the cost-basis information is reported on Form 1099-B. For grants made in 2014 and later years, brokers are prohibited from including equity compensation income (which appears on Form W-2) in the cost basis reported on Form 1099-B. This creates confusion and complications with the reporting of stock sales from stock compensation on IRS Form 8949 and Schedule D.
Alert: If you sold stock, such as company shares acquired from equity comp, at a loss to harvest the losses and soon afterward repurchased the same stock, you may have triggered a "wash sale." This is reported differently on Form 8949 (see the FAQ on this topic).
For guidance on the tax-return reporting for sales of shares acquired through stock compensation, including annotated diagrams of Form 8949 and Schedule D, see the section Reporting Company Stock Sales in this website's Tax Center.
How The 2018 Tax Reform Continues To Affect Tax Returns
The "Tax Cuts & Jobs Act" (TCJA), which took effect in 2018, reduced the rates of the seven income brackets, and changed the income thresholds that apply for higher tax rates. The rates of the seven tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. This lowered rates for compensation income, interest, ordinary dividends, and short-term capital gains.
The flat supplemental wage rate for federal income tax withholding on stock compensation is based on the seven brackets. For amounts up to $1 million in a tax year it is linked to the third lowest rate (22%). For amounts in excess of $1 million in a tax year it is linked to the highest rate (37%).
As shown by the table below, the 22% rate of withholding may not cover the actual taxes you will owe on the additional taxable income from stock compensation. You must therefore know the tax bracket for your total income. Assess the need to put money aside for payment with your tax return, or pay estimated taxes.
Income Tax Brackets And Rates In 2022
|RATE||TAXABLE INCOME (SINGLE)||TAXABLE INCOME (JOINT)|
|10%||$0 to $10,275||$0 to $20,550|
|12%||$10,275 to $41,775||$20,550 to $83,550|
|22%||$41,775 to $89,075||$83,550 to $178,150|
|24%||$89,075 to $170,050||$178,150 to $340,100|
|32%||$170,050 to $215,950||$340,100 to $431,900|
|35%||$215,950 to $539,900||$431,900 to $647,850|
|37%||more than $539,900||more than $647,850|
For stock compensation, multi-year planning remains useful to minimize when the added income pushes you into a higher tax bracket.
Changes In The Calculation Of The Alternative Minimum Tax (AMT)
The income spread upon the exercise of incentive stock options (ISOs) can trigger the AMT, which can warrant complex tax planning. The AMT and how it applies to ISOs was not repealed, and below are the 2022 numbers in the AMT calculation (adjusted annually for inflation).
|Filer status in 2022||AMT income exemption amount||Exemption amount phaseout starts||Exemption amount phaseout ends||Point where rate
26% to 28%
(married filing separately: $103,050)
Under the TCJA, the higher AMT income exemption amounts and much higher income point where the phaseout starts make it much less likely that ISOs will trigger the AMT.
What pays in part for this change in the AMT calculation is the $10,000 cap on the deduction for state and local income taxes (SALT) and real-estate property taxes on tax returns. Given the odd way in which the AMT is calculated, those deductions may have triggered or added to your AMT in the past. Given that cap on SALT deductions, a taxpayer who has been paying the AMT may see less tax savings than they might otherwise expect to get from the AMT change.
Alert: When you are deciding whether to exercise ISOs and hold the shares, you still want to determine whether the difference between your long-term capital gains rate and your short-term capital gains rate (same as your income tax rate) justifies the risk of holding shares for a qualifying disposition. Whether or not you have to pay the AMT should not, on its own, be the determining factor in your ISO strategy.
No Change In The Long-Term Capital Gains Rates (0%, 15%, 20%)
The reduction in the ordinary income rates, which apply to short-term capital gains, lowers the difference between your short-term and long-term capital gains rates. This reduced differential may affect your tax-planning decisions, e.g. whether to hold or sell shares at exercise, vesting, or purchase. While there is no change in the already low long-term capital gains rates, the tax law created new inflation-indexed taxable income thresholds above which the rate on long-term capital gains and qualified dividends goes from 0% to 15% and 15% to 20%.
Capital Gains Rates And Taxable Income Thresholds For The 2022 Tax Year
|Filer status||0% tax rate on capital gains||15% tax rate on capital gains||20% tax rate on capital gains||3.8% Medicare surtax on capital gains|
|Single||Not over $41,675||Over $41,675 but not over $459,750||Over $459,750||Over $200,000|
|Joint||Not over $83,350||Over $83,350 but not over $517,200||Over $517,200||Over $250,000|