RSUs, ESPP and stock options: the basis trap and the under-withholding problem

Many NRIs in technology are paid partly in company stock. It is also the area where the largest avoidable overpayment of US tax happens.

RSUs

When RSUs vest, the market value of the shares is ordinary income, reported on your W-2. Your cost basis for later sale is that same value on the vest date.

The trap: many brokers report basis on Form 1099-B that leaves out the shares sold to cover withholding or reports a zero basis for "noncovered" shares. If you accept the form as shown, the vest income is taxed once as wages and again as capital gain. Correct it on Form 8949 with an adjustment, and keep the vest records.

Withholding is too low

Companies withhold federal tax on stock income at a flat supplemental rate, 22% on amounts up to $1 million and 37% above that. If your marginal rate is 24% or higher, this under-withholds. Add state tax, and the April payment can be large. Fix it with a higher W-4 withholding, quarterly estimates, or both (see withholding article).

ESPP

Under a qualifying ESPP, the discount is taxed on sale. The treatment depends on whether the sale is a qualifying disposition (held two years from grant and one year from purchase) or a disqualifying one. In both cases, part of your gain is ordinary income, and the broker form usually does not reflect it. This is another place where the basis on the 1099-B needs adjusting.

ISOs and the alternative minimum tax

For incentive stock options, there is no regular tax at exercise if you hold the shares. But the spread (market price minus exercise price) is a preference item for the alternative minimum tax in the year of exercise. A large exercise can produce an AMT bill on shares you have not sold, and if the price then falls, the tax paid is not refunded, though an AMT credit carryforward is available. Two rules to check before exercising:

1. Model the AMT on the exercise using your actual income, not an estimate.
2. Remember the holding periods (two years from grant, one year from exercise) for the sale to receive capital gain treatment.

NSOs are simpler: the spread is wages at exercise.

Moving between countries or states

Equity that was earned partly in India, partly in one US state and partly in another is usually apportioned between them by the vesting period, and each jurisdiction can claim its share. Employers' payroll systems get this wrong often. If you moved during the vesting period, check the W-2 state boxes and the split.

Sale proceeds and the next steps

• Sales within one year are taxed at ordinary rates; after one year at 0, 15 or 20%, plus the 3.8% net investment income tax above the income thresholds.
• Wash-sale rules disallow a loss if you re-buy within 30 days, including through a vest or ESPP purchase.
• If you hold shares in an India-based parent's plan, see Indian business and share interests.