By |Published On: Nov 27, 2023|Categories: Financial Planning, ISOs|

When it comes to paying taxes on Incentive Stock Options (ISOs), it can be very complicated. Now, ISOs have an incentive, but in my book, they are stock options that have a lower tax amount if you own them long enough. The ISO acronym that is appropriate is – “I sell out (ISO) in the future.”

Over the Thanksgiving weekend, I bumped into my old high school friend, Tim, at a local Greek restaurant. Tim is tall, athletic, with broad shoulders. He went to college on a football scholarship and off of the field, he is very gentle and loves conversing.

We haven’t seen each other in years and we caught up for hours. The restaurant was closing and they asked us to leave. Before we left, he shared a story about how he ran into some tax trouble with ISOs.

Tax Challenges with ISOs

Back in 2019, he exercised and sold a lot of ISOs. When tax time came around, his company accidentally reported his ISO income on both his W2 and on a 1099 form. Unfortunately, he was taxed twice on the same income.

When he filed his taxes for that year, he did not know there was an error in ISO tax reporting. However, the following year he recognized the mistake and he filed an amended tax return.

This process took some time as he located the old tax documents. He described the agony of filing an amended tax return.

The IRS recognized that he was correct and he received his $400K of overpaid taxes in 2023 – 4 years later!

To miss out on having that amount of money for over 4 years is painful. It means having his kids’ college education fund topped up, a new home, or relief from the stress of the daily grind.

What to Watch Out For

When it comes to ISO tax reporting, be sure that you are only taxed once, and the taxes are properly reported on your W2 and 1099. If you find an error, take it up with your company and get the tax documentation resolved.

Furthermore, be sure that the income and tax numbers on your W2 match your year end pay stub. Discrepancies have a habit of showing up on these two documents as well.

The goal is to make sure that your taxes are accounted for properly, and you pay the tax that you owe.

A lump sum of $400K can transform your whole life and attitude about money. It is significant in a wider context because with this amount of money, you can start developing your own private economy, and it doesn’t matter what’s going on in the larger, global economy. Can you imagine what Tim’s life would be like if he recognized the error in tax reporting?