The IRS has yet again revised the Form 1040 tax return and its reporting procedures.

Ready or not, tax-return reporting has changed yet again for the 2022 tax-return season (income received in 2021). 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 2021 tax year.

The IRS Form 1040 for 2021 remains at 38 lines, to which it was expanded after being condensed in 2018 to just 24 lines in an effort make it "postcard size." Highlights of Form 1040 changes are explained below in detail:

  • Schedule 1 (under "Other Income") of Form 1040 is where you should enter the amount of any stock compensation that was omitted on your Form W-2.

  • Schedule 3 of Form 1040 now has a specific line for any credit for prior minimum tax. This would apply to anyone with incentive stock options (ISOs) who has triggered the alternative minimum tax (AMT).

  • Schedule 2 of Form 1040 now has dedicated lines for amounts coming from the tax form for the Additional Medicare Tax on compensation income and the tax form for the Net Investment Income Tax (e.g. on capital gains and dividends).

  • The totals on Schedule 1, Schedule 2, and Schedule 3 of Form 1040 appear on different lines on those schedules, but are entered on the same lines of Form 1040.

To prevent mistakes with tax-return reporting, see also the insights in the article series on stock options and ESPPs and on restricted stock/RSUs.

Highlights Of Form 1040

Below are key aspects of the Form 1040 tax return, its associated schedules and forms, and more details on changes for the 2022 tax season.

1. Compensation. Stock compensation, along with salary income reported on Form W-2, is entered on Line 1 of Form 1040.

Image of IRS Form 1040 with Line 1 highlighted

2. Capital gain or loss. If you sold shares during the 2021 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.

Image of IRS Form 1040 with Line 7 highlighted

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.

Image of Form 6251 with line 2i highlighted.

When the ISO stock that triggered the AMT is sold, the difference from the ordinary tax is reported on Line 2k.

Image of Form 6251 with line 2k highlighted.

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.

Image of IRS Form 1040 with Line 17 highlighted

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 6b, "Credit for prior year minimum tax."

Image of Schedule 3 with Line 6b highlighted

The totals from Part I of Schedule 3 go into Line 20 of Form 1040.

Image of IRS Form 1040 with Line 20 highlighted

4. 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.

5. Equity Compensation Income Left Off W-2

If your company does not report your employee stock compensation on Form W-2, the revised Schedule 1 for the 2021 tax year indicates that the amount goes in the "Other Income" section on Line 8j ("Stock Options").

Image of Schedule 1 with Line 8j highlighted

The list of items "a" through "p" (plus "z") under "Other Income" on Schedule 1 is new for the 2021 tax year. Previously, taxpayers listed the type of other income and the amount, or put the details in a supplemental attachment.

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 draft instructions (pages 86–87), the IRS has made it clear the section "Other Income" is where to put employee stock option income left off a W-2:

Line 8j Stock options. Enter on line 8j any income from the exercise of stock options not otherwise reported on your Form W-2.

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, based on the revised Schedule 1 and instructions, the proper reporting is on Schedule 1, with the totals there going into Line 8 of Form 1040.

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 8j, then it can fit into Line 8z ("Other Income. List type and amount").

Image of Schedule 1 with Line 8z highlighted

The reporting for nonemployees would not be on the W-2, as explained in the discussion of Form 1099-NEC above.

6. 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 2021 Form 1040, estimated tax payments are reported on Line 26.

7. Additional Medicare Taxes

An extra 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 these same 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, see a related FAQ.

On Schedule 2 for the 2021 tax year, 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.

8. Recovery Rebate Credit. To mitigate the economic impact of the pandemic, Congress provided a third stimulus payment made in 2021, with eligibility phased out according to income from your last processed tax return. The third round of Economic Impact Payments were advance payments of the 2021 Recovery Rebate Credit claimed on the 2021 tax return. If your prior year's income didn't qualify you for the third Economic Impact Payment or you did not receive the full amount, you may be eligible for the Recovery Rebate Credit, depending on your 2021 tax information.

Income spikes from stock compensation in past years may have disqualified you from this payment, even if in 2021 you resigned or were laid off or furloughed. 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 2021 income be higher than in the past, perhaps (again) from stock compensation.

In early 2022, the IRS will send Letter 6475 that contains the total amount of the third Economic Impact Payment and any Plus-Up Payments received. With your other tax records, you should keep this and any other IRS letters about stimulus payments. You will need the amount of your third Economic Impact Payment and any Plus-Up Payments received to calculate the correct 2021 Recovery Rebate Credit amount when you file your tax return.

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 2021

RATE TAXABLE INCOME (SINGLE) TAXABLE INCOME (JOINT)
10% $0 to $9,950 $0 to $19,900
12% $9,951 to $40,525 $19,901 to $81,050
22% $40,526 to $86,375 $81,051 to $172,750
24% $86,376 to $164,925 $172,751 to $329,850
32% $164,926 to $209,425 $329,851 to $418,850
35% $209,426 to $523,600 $418,851 to $628,300
37% more than $523,600 more than $628,300

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 2021 numbers in the AMT calculation (adjusted annually for inflation).

Filer status in 2021 AMT income exemption amount Exemption amount phaseout starts Exemption amount phaseout ends Point where rate
rises from
26% to 28%
Single $73,600 $523,600 $818,000 $199,900
(married filing separately: $99,950)
Joint $114,600 $1,047,200 $1,505,600 $199,900

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%.

Capital Gains Rates And Taxable Income Thresholds For The 2021 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 $40,400 Over $40,400 but not over $445,850 Over $445,850 Over $200,000
Joint Not over $80,800 Over $80,800 but not over $501,600 Over $501,600 Over $250,000