Ready or not, tax-return reporting has significantly changed for the 2019 tax-return season, and the tax reform that become effective in 2018 has altered tax rates and brackets. This article explains all of the changes employees with stock compensation need to know for 2018 tax returns, to be filed by April 15, 2019.

The major sets of changes to understand:

  1. The IRS Form 1040 tax return has been condensed and new schedules (supplementary forms) funnel information to Form 1040. The other tax returns of the past, Form 1040A and Form 1040 EZ, have been eliminated.
  2. Total capital gain or loss on Schedule D is now entered on Schedule 1. It is no longer directly entered on Form 1040. The AMT calculation on Form 6251 is now entered on Schedule 2 (see the related FAQ).
  3. The tax-reform legislation that took effect in 2018 (the Tax Cuts & Jobs Act) affects the tax rates that apply to stock compensation.

These changes are detailed below.

Alert: On the IRS draft of the 2019 Form 1040 (i.e. for the 2020 tax-return season), it appears that for 2019 taxes the capital gains total will return to Form 1040 instead of being reported on Schedule 1. For details, see our commentary on this development in the myStockOptions.com Blog.

Overhauled IRS Form 1040

The IRS has overhauled the Form 1040 tax return, creating what it believes is a "simpler" form for the 2019 tax season. This replaces the former well-known structure of the 1040 and eliminates the other tax returns of the past, Form 1040A and Form 1040 EZ.

Form 1040 now has just 23 lines. Using what it calls a "building block" approach, the IRS created an additional six new schedules that funnel information to Form 1040. That is where you now first enter many of the numbers you previously reported on Form 1040.

Tax-Reporting Changes

The tax treatment for stock compensation and sales of company stock has not changed. What is different is where and how the related items are reported on your tax return. The major changes to know about include:

1. Compensation reporting. Stock compensation as well as salary income is now reported on Line 1 of Form 1040 (previously Line 7).

Image of Form 1040 with Line 1 highlighted

2. Stock-sale reporting. When you are reporting a sale of company stock, you still first report it on Form 8949 and enter the totals from 8949 on Schedule D. That part has not changed. However, Form 1040 no longer has a line labeled "Capital gain or (loss)." Instead, the total from Schedule D is now entered on Line 13 of the new Schedule 1 ("Additional Income and Adjustments to Income").

Image of Form 1040 Schedule 1 with Line 13 highlighted

Schedule D is attached to Schedule 1. Totals from Schedule 1 funnel into Form 1040 as part of the amount reported on Line 6, "Total income" (see Form 1040 image above).

3. Other income reporting. The new Schedule 1 is also where you put any stock compensation income not reported on Form W-2. It goes on Line 21 ("Other income"). This can happen in certain circumstances, such as in a qualifying disposition of ESPP stock. You report the amount on Line 21 with a short explanation, such as "income at sale of ESPP stock from [X corporation]."

Image of Form 1040 Schedule 1 with Line 21 highlighted

When this "other income" line appeared on Form 1040, it sometimes created confusion about whether to report income on that line from Box 12 or Box 14 of the W-2. Reporting it on that line was a mistake if it had already been reported on the W-2 as part of Box 1 income. The separation of this line from the 1040 itself reduces the potential for making that reporting error, which could result in paying taxes twice on the same income.

4. AMT reporting. Alternative minimum tax (AMT), a concern for anyone with incentive stock options (ISOs), is no longer directly reported on Form 1040 from the calculation on Form 6251. Instead:

  • The AMT, if owed, from the Form 6251 calculation now goes into Line 45 of Schedule 2 ("Tax"). Attach Form 6251 to Schedule 2. The totals from this schedule go into Line 11 of Form 1040.
  • The Form 6251 has new numbers for all its lines. The spread at ISO exercise is reported on Line 2i (previously Line 14). When the ISO stock that triggered the AMT is sold, the difference from the ordinary tax is reported on Line 2k (previously Line 17).
  • 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 now goes on Schedule 3 ("Non-Refundable Credits") Line 54 (check box b). The totals from Schedule 3 go into Line 12 of Form 1040. (Previously the Line 25 total from Form 8801 went directly onto 1040 Line 54.)

Image of Form 1040 Schedule 2 with Line 45 highlighted

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 Tax Reform Affects Tax Returns

The Tax Cuts & Jobs Act (tax reform) is filled with many provisions. A few of them affect the taxes on stock compensation and sales of company shares that you’ll be paying on your tax return.

1. Changes in the rates of individual income tax. The Tax Cuts & Jobs Act keeps the current seven income tax brackets, reducing the rates and changing the income thresholds that apply. The rates are now 10%, 12%, 22%, 24%, 32%, 35%, and 37%, with the top bracket starting at $600,000 for joint filers ($500,000 for single filers). This means you have lower rates for compensation income, interest, ordinary dividends, and short-term capital gains.

Withholding

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 it is linked to the third lowest rate (22%). For amounts over $1 million it is linked to the highest rate (37%).

As shown by the table below, depending on the tax bracket for your total income the 22% rate of withholding may not cover the actual taxes you owe on the additional taxable income from stock compensation in 2018. Unless you paid estimated taxes or put money aside to cover the expected shortfall, be prepared to pay more taxes with your return.

Income Tax Brackets And Rates In 2018

RATE TAXABLE INCOME (SINGLE) TAXABLE INCOME (JOINT)
10% $0 to $9,525 $0 to $19,050
12% $9,526 to $38,700 $19,051 to $77,400
22% $38,701 to $82,500 $77,401 to $165,000
24% $82,501 to $157,500 $165,001 to $315,000
32% $157,501 to $200,000 $315,001 to $400,000
35% $200,001 to $500,000 $400,001 to $600,000
37% Over $500,000 Over $600,000

2. Changes in the calculation of the alternative minimum tax (AMT). The income spread at incentive stock options (ISOs) exercise can trigger the AMT, which warrants complex tax planning. Below are the 2018 numbers in the AMT calculation (adjusted annually for inflation). These higher AMT income exemption amounts, and the much higher income point where the phaseout starts, make it much less likely that ISOs will trigger the AMT.

  • The 2018 AMT income exemption amount rose to $70,300 (from $54,300) for single filers and to $109,400 (from $84,500) for married joint filers.
  • The income where this AMT income exemption starts to phase out in 2018 is substantially adjusted upward to begin at $500,000 for individuals (up from $120,700 in 2017) and $1,000,000 (up from $160,900 in 2017) for married couples.

For the 2019 AMT numbers, see the FAQ on the AMT calculation.

3. No change in the long-term capital gains rates (15% and 20%). While there is no change in the long-term capital gains rates, the tax law created new income thresholds for when the rate on long-term capital gains and qualified dividends goes from 15% to 20%. For 2018, the thresholds are more than $479,000 for married joint filers and $425,800 for single taxpayers (in 2019, $434,550 for single taxpayers and $488,850 for married joint filers). Those thresholds, which are indexed for inflation, are no longer similar to that of the top tax bracket.