NOTE: This is by no means tax advice. It's largely so I can bitch a little and see if I can figure out what's going on while I try to get my taxes right.
Many companies (including mine) offer an employee stock purchase plan (ESPP). Stock purchase plans provide employees with a way to purchase stock at a discount (and if done right, get an almost guaranteed profit).
The way most stock plans work is that some percentage of the employee's income is deducted and put into a special stock purchase account. Most plans use a period of 6 months, beginning August 1 and ending February 1 (or vice versa). Under the plan, the employee's deducted money is used to buy company stock. The stock is purchased at 85% of the lower of the price at the start and end of the period. This is a good deal. If the stock goes up over the 6 months, the employee buys stock at 85% of the lower start-of-period price (a gain of over 15%). If the stock went down, the employee still has an immediate 15% gain if the stock is sold immediately. Of course, taxes are lower if the employee holds on to the stock for at least a year, but at the risk the stock will go down, wiping out any gains. So many employees sell their stock as soon as it is granted (locking in the gain).
The problem I've found with employee stock plans comes at tax time. The moderately complex tax rules combine with really poor information to make it very easy to pay too much tax. This year it appears the IRS has new rules which make it even more likely too much tax will be paid.
The tax issue begins with how the stock plan is taxed. This discussion assumes the stock is sold immediately (so short term gains). I have a few shares of stock which qualify for long term gains but haven't had to figure those out.
Assume stock is purchased for the ESPP and then sold. There are several amounts involved. First is the amount of employee money used to purchase the stock. Second is the market price when the stock was purchased. for instance, suppose the stock went down in price over the plan period and was at $100 per share when stock was purchased. The employee pays $85 (15% less) for the stock. Suppose the employee then sells the stock for $101 per share. What happens tax wise and what is reported to the emplyee?
Tax wise, $15 per share (the purchase discount) is considered ordinary income. This amount is included in the employee's W-2, however it is not separated out. I discovered this because my W-2 wages are more than the total wages of my last paycheck by exactly the amount of the ESPP discount.
So the purchase discount ($15 per share) is ordinary income AND has been reported to the IRS as income. When I later sell the stock for $101, I have an additional gain of $1 per share (minus commissions). This is a short term capital gain, reported on schedule D and form 8949 (with box A checked).
So now turn to my brokerage 1099 form which now reports the basis and sale price of stock (and is reported to the IRS). The 1099 reports the amount received from the stock sale, however under IRS rules reports the purchase price ($85 per share) as the "cost or other basis", not the $100 per share which is the actual basis (since the $15 per share difference has been reported as W-2 wages). The broker CANNOT report $100 per share as the basis, even though this is the actual basis.
This leaves several areas of confusion. First, anybody who copies 1099 basis and sale amounts onto their tax form is being double taxed for the 15% discount. Instead, you need to be smart enough to use the actual basis ($100 per share). Second, we need to hope the IRS is smart enough to figure this out, especially because as far as I can tell the IRS is not specifically told that the $15 per share discount has been included in income (perhaps this is requirement though). Third, it's my understanding that the discount (15%) amount is not included on the W-2 if you don't sell the stock that year. So I'm not sure what's reported if I hold the stock into the next year (but less than 12 months). It's more confusing if I sell the stock after I've left the company. Is something still added to my W-2? Do I get a special W-2 just for stock gains if I sell in the next calendar year? Finally, if the stock is held long term (I have some ESPP stock I've held for 13 years and counting), there are other odd tax rules which I haven't figured out. I think some of the income (15% discount) turns into long term gains but am not sure. I'll find out if I ever sell that stock.
Note the above references to 15% or $15 assume that the stock went down during the ESPP 6 month period. If the stock went up the discount (and income gain) could be a much higher percentage. If the stock started at $100 and was at $150 at the end of the period, it would still be purchased at $85. The income gain is then $65 per share and the cost basis for any sale $150. But the 1099 still reports $85 per share (and the possible double taxation is that much higher.
Tax reporting rules have generally made it easier to do your taxes. The brokerage must now track your cost basis and report it along with the sale price. But for ESPP plans the reported basis is not the correct figure, and teasing out the correct information can be challenging.