Tax Season 2021: What You Must Know About New Reporting Rules
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Ready or not, tax-return reporting has changed yet again for the 2021 tax-return season (income received in 2020). 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, this article explains what you need to know about tax returns for the 2020 tax year.
Highlights of the changes (explained below in detail):
- After being condensed to just 24 lines in 2018, the IRS Form 1040 for 2020 has expanded to 38 lines.
- New lines include those for the Recovery Rebate Credit (stimulus check) and for estimated tax payments, sometimes made by taxpayers who have stock compensation.
- Total capital gain or loss from Schedule D is entered on a different line of Form 1040.
- The totals on Schedule 2 and Schedule 3 are entered on different lines of Form 1040. This applies to anyone with incentive stock options (ISOs) who has triggered the alternative minimum tax (AMT).
- For nonemployees, income is now reported on IRS Form 1099-NEC, not Form 1099-MISC.
- The 2018 tax reforms continue to affect tax rates that apply to stock compensation and sales of company stock.
Alert: In March 2021, the IRS also postponed the filing deadline for 2020 tax returns. Tax Day 2021 is May 17.
Revised Form 1040
1. Compensation. Stock compensation, along with salary income reported on Form W-2, is entered on Line 1 of Form 1040.
2. Capital gain or loss. If you sold shares during the 2020 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 (note that this has changed from Line 6 on the 2019 form).
3. Alternative minimum tax (AMT). 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.
When the ISO stock that triggered the AMT is sold, the difference from the ordinary tax is reported on Line 2k.
You enter your Form 6251 calculation on Line 1 of Form 1040's Schedule 2 ("Tax"). You attach Form 6251 to Schedule 2. The totals from Part I of Schedule 2 go into Line 17 on Form 1040 (note that this has changed from Line 12b on the 2019 form).
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. The amount from Line 25 of Form 8801 goes into Schedule 3 ("Non-Refundable Credits") on Line 6 (check box b). The totals from Part I of Schedule 3 go into Line 20 of Form 1040 (note that this has changed from Line 13b on the 2019 form).
4. Recovery Rebate Credit. To mitigate the economic impact of the pandemic, Congress provided two stimulus checks/economic-impact payments that were based on income from 2019 tax returns (or 2018 if your 2019 return was not available for the first check). The amount received for the first check and/or the second payment is phased out according to income in that prior year.
Because of income spikes from stock compensation in recent years, you may not have qualified for this federal assistance, even if you were laid off or furloughed during 2020. Should this be your situation, you can instead claim the Recovery Rebate Credit on Line 30 of Form 1040. In further good news, you have no recapture of the stimulus checks you received, should your 2020 income be higher than in the past, perhaps (again) from stock compensation. See the Form 1040 instructions for the Recovery Rebate Credit Worksheet. If you received IRS Notice 1444 ("Your Economic Impact Payment") for the first stimulus check or IRS Notice 1444-B for the second, have these available when completing the worksheet to do the calculation.
5. Estimated taxes. 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. As a result, you may have paid estimated taxes because of income from restricted stock/RSU vesting, NQSO exercises, ISO exercises, or an ESPP purchase/sale. On the 2020 Form 1040, estimated tax payments are now reported on Line 26. This differs from last year, when estimated tax payments were reported on Schedule 3 with the total funneled onto Form 1040.
New IRS Form 1099-NEC For Nonemployees
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 and the income from exercise or vesting now appears on IRS Form 1099-NEC ("Nonemployee Compensation") as self-employment income. (Before 2020, it was Form 1099-MISC.)
Income is reported on Form 1099-NEC in Boxes 1 and 7. You report this income on Schedule C of your Form 1040 tax return. As the income is self-employment income, you also need to calculate on Schedule SE any Social Security and Medicare taxes that you owe.
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.
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-tax 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 2020
|RATE||TAXABLE INCOME (SINGLE)||TAXABLE INCOME (JOINT)|
|10%||$0 to $9,875||$0 to $19,750|
|12%||$9,876 to $40,125||$19,751 to $80,250|
|22%||$40,126 to $85,525||$80,251 to $171,050|
|24%||$85,526 to $163,300||$171,051 to $326,600|
|32%||$163,301 to $207,350||$326,601 to $414,700|
|35%||$207,351 to $518,400||$414,701 to $622,050|
|37%||$518,401 or more||$622,051 or more|
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 warrants complex tax planning. While the AMT or how it applies to ISOs was not repealed, below are the current numbers in the AMT calculation (adjusted annually for inflation).
|Filer status in 2020||AMT income exemption amount||Exemption amount phaseout starts||Exemption amount phaseout ends||Point where rate
26% to 28%
(married filing separately: $98,950)
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. Strangely enough, 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. That you don't have to pay the pesky 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 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%. In the 2020 tax year, for example, the 20% capital gains rate applies to single taxpayers with taxable income of more than $441,450 and to married joint filers with taxable income of more than $496,600. These thresholds no longer line up with federal income tax brackets.