Reporting NQSO and Stock Option Income on W2: Venture Shareholders’ Guide

Introduction

When your startup employees exercise stock options, it is crucial to report the transaction correctly to the IRS. Whether you are an employee or a contractor, the tax form you receive depends on the type of stock option exercised. This guide provides a detailed overview of the reporting process forRSUs, ISOs, NQSOs, and contractors exercising NQSOs. By understanding these requirements, you can ensure compliance and avoid potential penalties.

Overview of Stock Options and their Reporting

Stock options, including RSUs (Restricted Stock Units), ISOs (Incentive Stock Options), and NQSOs (Non-Qualified Stock Options), are common forms of equity compensation in startups. When these options are exercised, employees and contractors must report the income generated to the IRS and receive the appropriate tax forms.

Startup Employee Exercises an RSU

When a startup employee exercises an RSU, they need to be provided with an updated W-2 tax form by the employer. The employer must edit boxes 1–6 and 16–19 of the W-2 by January 31 of the following year. Most payroll providers will ask whether you issued NQSOs to employees in December to facilitate the early issue of W-2s. It is imperative to respond to these end-of-year surveys promptly.

Startup Employee Exercises an ISO

When a startup employee exercises an ISO, the employer must provide the employee with Tax Form 3921 by January 31 of the following year. It is important to note that ISOs can only be issued to employees, not contractors. Companies often use Carta to track and record these transactions, but they do not file the 3921s for you. Instead, you need to file with the IRS.

For startups using Carta, you will need a unique TCC (Tax Compliance Code) to file your 3921s. Applying for and receiving a TCC code can take several weeks, so it is recommended to file your 3921s on Track1099 and transfer the information from Carta.

Startup Employee Exercises an NQSO

When a startup employee exercises an NQSO, they should receive an updated W-2 tax form by the employer. The employer must edit box 12 Code 5 by January 31 of the following year. As with RSUs, most payroll providers will ask whether they issued NQSOs to employees in December to facilitate the early issue of W-2s. It is crucial to respond to these end-of-year surveys promptly.

Startup Contractor Exercises an NQSO

When a contractor exercises an NQSO, they should receive a Tax Form 1099-NEC and their contractor’s information should be filled in Box 7 Non-Employee Compensation. For tax years before 2020, a 1099-MISC was used. Track1099 is an excellent platform for filing 1099s online.

Conclusion

Ensuring accurate reporting of stock option income is crucial to maintaining compliance with IRS regulations. By understanding the specific requirements for each type of option and the appropriate tax forms, you can avoid potential penalties and ensure a smooth tax season. Whether you are a startup employee or a contractor, make sure to stay informed and take the necessary steps to report your income correctly.