In this article, we'll explore how to enter equity compensation income and subsequent sales of that company stock within Scenario Analysis. Our video below (timestamps in parentheses) walks through how to enter each type of equity compensation.
- Stock Grant Bonus - 1:59
- Restricted Stock Units (RSUs) - 06:08
- Nonqualified Stock Options (NQSOs) - 09:36
- Incentive Stock Options (ISOs) - Qualified Disposition - 13:08
- Incentive Stock Options (ISOs) - Disqualifying Disposition - 23:54
- Employee Stock Purchase Plans (ESPPs) - 26:57
Equity Compensation Spreadsheet Template
If you want a deeper dive on the basics of equity compensation, check out the hour-long webinar and slides at the bottom of this article from our March 2022 webinar hosted by Ben Birken, our VP of Customer Success and Engagement.
Understanding the timing of income from equity compensation is a critical first step in modeling out that income. Generally, equity compensation awards originate from a grant letter. This generally will have details such as the vesting schedule, any expiration dates for options, and other important information. Using that information to map out the timing of income is a good first step to understanding the tax picture of your client's equity compensation.
While there are similarities in how equity compensation is taxed, one big difference is when those taxes are applied. Equity compensation includes either a grant of shares or options to exercise the right to purchase shares of company stock. So, when does equity compensation get recognized as income? There are generally two trigger points:
Stock GRANTS are taxed when the stock Vests.
Stock OPTIONS are taxed when the stock option is Exercised.
Income from stock grants, restricted stock units (RSUs), and non-qualified stock options are all included as wage income and are taxable for income tax purposes and for payroll taxes (FICA) on a taxpayer's W-2. As such, you will want to enter income from those three types of equity compensation in the Wages Worksheet within Scenario Analysis. You can access that worksheet by clicking on the pencil icon circled below.
Stock Grants and Restricted Stock Units (RSUs):
When a stock is granted to an employee, the stock is considered taxable income (both for income taxes and for payroll (or FICA) taxes when that stock vests. The income recognized is equal to the fair market value (FMV) of the shares on that vest date times the number of shares vesting. You will want to enter that income in Wages Worksheet fields outlined in green above for stock grants (bonus) or RSUs, respectively.
When selling those shares of stock, the gain is taxed as any other stock gain - a short-term or long-term (if held from one year after acquisition - the vest date) capital gain based on the holding period of the stock upon sale. The basis per share is equal to the FMV per share at vesting. You will want to enter any net gain/loss from the sale in the "Schedule D Income" section of Scenario Analysis.
Non-Qualified Stock Options (NQSOs):
Stock options are taxed not when the stock vests, but instead when the option to purchase those shares is exercised. The taxable income (both for income taxes and for payroll (or FICA) taxes) recognized is equal to the bargain element (aka the spread) times the number of shares exercised. The spread is equal to the FMV on the exercise date less the strike price stated in the grant letter. You will want to enter that income in Wages Worksheet fields outlined in red above.
When selling those shares of stock, the gain is taxed as any other stock gain - a short-term or long-term (if held from one year after acquisition - the exercise date) capital gain based on the holding period of the stock upon sale. The basis per share for these NQSOs is equal to (the strike price times + the bargain element). You will want to enter any net gain/loss from the sale in the "Schedule D Income" section of Scenario Analysis.
Incentive Stock Options (ISOs):
Note: If you are modeling capital gains that include both ISO-related gains/losses and non-ISO-related gains/losses, you must first manually separate out the ISO-related shares and non-ISO-related shares. Tracking these gains separately within a spreadsheet is often the best way to track the different lots at play.
Qualified Disposition:
So, what is makes the disposition (sale) of ISOs qualified, and why does it matter? The reason it matters is that there is a distinction between how ISOs are taxed, depending on whether those ISOs are sold as a qualified disposition or a disqualifying disposition. A qualified disposition occurs when ISOs are exercised in one tax year and then sold:
- more than one year after the exercise date (in another tax year), and
- more than two years after the grant date (when the shares were awarded).
A disqualifying disposition is a sale of ISO shares that fail to meet both of the requirements of a qualified disposition mentioned above. Since they are treated differently for taxes, how you model ISOs in Holistiplan depends on whether the sale of those ISOs is a qualified disposition or a disqualifying disposition.
While the exercise of ISOs is not taxable under the regular tax calculation (except in the case of disqualifying dispositions - covered later), there is an impact under the AMT calculation on Form 6251. Therefore, no income must be recognized in the regular tax calculation and no entry is made in the Wages Worksheet when exercising an ISO.
However, the difference between the market price and the exercise price (the bargain element or the spread) is a preference item for Alternative Minimum Tax (AMT). To model ISO exercises and the impact on AMT, expand the "Alternative Minimum Tax" section outlined in red below, and enter the amount of the preference item (the bargain element per share times the number of shares exercised) in the row titled “2i Incentive Stock Options” outlined in blue below. You can click the "Solve for Max" gear icon circled in red below if you want to know how much of a preference item you can have from exercising ISOs and still avoid AMT!
When selling those ISOs as part of a qualified disposition, the gain on those ISOs is by it's very nature taxed as a long-term capital gain. However, the entries to record the sale of that stock have to be made in three separate places:
- Schedule D - to reflect the capital gain under the regular tax calculation,
- Schedule D for AMT - to reflect the gain under the AMT tax calculation, and
- Form 6251 - to reflect the negative adjustment for disposition of property on line 2k.
The basis per share under the regular tax calculation of these ISOs is the strike price. You would enter any net gain/loss from the sale in the "Schedule D Income" section of Scenario Analysis as you would a normal sale of stock - with the proceeds less the basis equaling the net gain.
The basis under the calculation of Schedule D for AMT adds one other component - the bargain element - to the calculation, so the basis per share under the AMT calculation for these ISOs would be the (strike price + the bargain element (FMV at exercise minus the strike price)). This higher basis under the AMT calculation will result in a lower gain/loss when compared to the gain/loss under the regular tax calculation. You will enter that AMT short-term or long-term gain/loss in the area outlined below.
Finally, once the gain/loss is entered accurately in both the regular "Schedule D Income" section and the AMT capital gains section, you will want to enter, as a negative number, the difference between the gain/loss under the regular tax calculation and the gain/loss under the AMT calculation. This negative difference is what should be entered as the "Disposition of Property" adjustment on line 2k within the AMT section where shown below. The formula for this adjustment on line 2k is:
-(gain/loss under the regular tax calculation - gain/loss under the AMT calculation)
Note: Remember, capital losses are capped at $3,000, both under the regular tax calculation and under the AMT tax calculation. Accordingly, you will want to factor that into your line 2k adjustment. See the examples on page 4 of the Form 6251 Instructions that speak to this limitation.
Disqualifying Disposition:
Modeling a disqualifying disposition of ISO shares is very similar to how you would model an NSO, with one exception - disqualifying dispositions of ISOs are not subject to payroll (FICA) taxes like NSOs are. Therefore, there is a slight difference in how to model them. To show the income recognized from the exercise of an ISO later sold in a disqualifying disposition, you would enter difference between the market price and the exercise price (the bargain element or the spread) as an income item in the "Other Income" Worksheet, which you can access by clicking on the pencil icon circled below.
You would then want to enter that spread as income in the "Stock Options" field outlined above within the "Other Income" Worksheet.
When selling those shares of stock, the gain is taxed as any other stock gain - a short-term or long-term (if held from one year after acquisition - the exercise date) capital gain based on the holding period of the stock upon sale. The basis for these shares is equal to the cost to acquire the shares (the strike price times the number of shares exercised). You will want to enter any net gain/loss from the sale in the "Schedule D Income" section of Scenario Analysis.
NOTE: If the sale of ISO shares related to a disqualifying disposition occurs in the same tax year as the exercise of those ISO shares, no reporting on Form 6251 is required. This is typically the case when utilizing a disqualifying disposition to exercise and immediately sell ISO shares to avoid AMT.
However, if the exercise and sale of ISO shares happen in different tax years, in addition to recording the sale on Schedule D for the regular tax calculation, you would also report the sale on Schedule D for AMT (to reflect the gain under the AMT tax calculation) and as a negative adjustment for disposition of property on line 2k in the "AMT" section of Scenario Analysis.
The basis under the calculation of Schedule D for AMT adds back the bargain element to the calculation, so the basis per share under the AMT calculation for these ISOs would be the (strike price + the bargain element (FMV at exercise minus the strike price)). This higher basis under the AMT calculation will result in a lower gain/loss when compared to the gain/loss under the regular tax calculation. You will enter that AMT short-term or long-term gain/loss in the area outlined below.
As a final step, once the gain/loss is entered accurately in both the regular "Schedule D Income" section and the AMT capital gains section, you will want to enter, as a negative number, the difference between the gain/loss under the regular tax calculation and the gain/loss under the AMT calculation. This negative difference is what should be entered as the "Disposition of Property" adjustment on line 2k within the AMT section where shown below. The formula for this adjustment on line 2k is:
-(gain/loss under the regular tax calculation - gain/loss under the AMT calculation)
Note: Remember, capital losses are capped at $3,000, both under the regular tax calculation and under the AMT tax calculation. Accordingly, you will want to factor that into your line 2k adjustment. See the examples on page 4 of the Form 6251 Instructions that speak to this limitation.
Employee Stock Purchase Plans (ESPPs):
ESPPs afford an employee to purchase company stock at a discount (15% is common), by electing an annual amount they wish to contribute via payroll deductions. At pre-determined times during the plan year, the plan purchases shares of stock with using money the employee contributed to the plan. While the decision to participate leads to payroll deductions for the employee, taxation under an ESPP does not occur when the shares of stock are offered or purchased, but rather when those shares are eventually sold.
When the shares within an ESPP are sold, to the extent of the discount afforded on the shares when purchased, the gain is first recognized as ordinary income. This income is reported on the employee's W-2, and is subject to income taxes and payroll (FICA) taxes. Once the discount has been fully accounted for, any remainder of the gain is treated as either a long-term or short-term capital gain, based on the holding period.
To qualify for long-term capital gains treatment, the ESPP shares must be held BOTH:
- More than one year from the purchase date, AND
- More than two years from the offer date.
To record ESPP income/gains in Holistiplan, you would enter the portion of the gain representing the discount on the shares as "Bonus" income in the Wages Worksheet, and the remaining gain in the "Schedule D Income" section, as either a short-term or long-term capital gain, as appropriate.
Taxation of Equity Compensation
Slides - Taxation of Equity Compensation
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