ESPP Offset: How to Correct Your Cost Basis

An Employee Stock Purchase Plan (ESPP) is a company-run program where employees can purchase company stock at a discount. Participants contribute through payroll deductions over an offering period. At the end of this period, the accumulated funds are used to buy stock on behalf of the participating employees.

Understanding ESPP Share Dispositions and Taxation

The tax implications of selling ESPP shares depend on how long you hold the stock. The holding period determines if the sale, or “disposition,” is qualifying or disqualifying, which impacts how your profit is taxed as ordinary income versus capital gains.

A qualifying disposition offers more favorable tax treatment. It requires the sale to be more than two years after the offering date and more than one year after the purchase date. When both conditions are met, your profit is split. The ordinary income portion is the lesser of the discount offered on the offering date or your total profit, with the remainder being a long-term capital gain.

A disqualifying disposition is any sale that fails to meet both holding period requirements. For these sales, the amount of ordinary income is the “bargain element,” which is the difference between the stock’s fair market value (FMV) on the purchase date and the discounted price you paid.

Any profit beyond this bargain element is a capital gain. Whether this gain is short-term or long-term depends on if you held the shares for more than one year. For example, if you sell nine months after purchase, the bargain element is ordinary income, and the additional gain is a short-term capital gain.

Identifying the Double Taxation Problem on Tax Forms

The potential for double taxation on ESPP shares comes from reporting on two different forms. For a disqualifying disposition, your employer reports the bargain element as compensation income on your Form W-2. This amount is included in your total wages in Box 1 and is often noted with code “V” in Box 12, meaning you have paid ordinary income tax on it.

Your brokerage firm also issues a Form 1099-B detailing the sale. The problem is that the cost basis reported in Box 1e on this form is typically just the discounted price you paid. It does not account for the compensation income already reported on your W-2.

This discrepancy means the bargain element is taxed once as ordinary income via your W-2. If you use the unadjusted cost basis from Form 1099-B, the same amount is taxed again as part of your capital gain. To avoid this, you must make a specific correction on your tax return.

Information Required to Calculate the Correct Cost Basis

To report the sale correctly, you will need your Form W-2, Form 1099-B, and statements from your ESPP plan administrator or broker. Your Form W-2 verifies the compensation income reported by your employer, while the Form 1099-B provides the sale proceeds and the unadjusted cost basis. From your plan statements, gather the following details:

• Grant Date (the start of the offering period)
• Purchase Date
• Sale Date
• Fair Market Value (FMV) per share on the Grant and Purchase Dates
• Discounted Purchase Price per share
• Sale Price per share
• Total Number of Shares Sold

Step-by-Step Guide to Reporting the Offset on Form 8949

The cost basis correction is made on Form 8949, “Sales and Other Dispositions of Capital Assets.” You must first report the transaction exactly as it appears on your Form 1099-B and then make a specific adjustment to offset the income already taxed.

Start by transcribing information from your Form 1099-B onto Form 8949. In column (a), describe the property (e.g., “150 shares of ABC Corp.”). In column (d), enter the total sale proceeds. In column (e), enter the cost basis exactly as it is shown on your 1099-B, even though it is incorrect.

The adjustment occurs in the next columns. In column (f), enter code “B” to indicate that the cost basis from Form 1099-B is incorrect. In column (g), you will enter the adjustment amount. This figure is the total bargain element that was included as income on your W-2.

Enter this amount as a positive number in column (g). This action increases your cost basis, which reduces your calculated capital gain and prevents double taxation. The final gain or loss is then calculated in column (h), and the totals from Form 8949 are carried over to Schedule D.