How vesting worksWith vesting, an employee earns benefits over time, rather than receiving them upfront. For example, a company might offer job candidates shares of stock if they accept an offer, but they will receive those shares only if they remain with the company for a certain amount of time—six months, a year, 3 years, and other variations. Commonly vested benefits include:
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Shares of company stockStock optionsEmployer contributions to a 401k or other retirement savings planThe right to receive pension benefitsBenefits generally vest in one of two ways:
In “cliff vesting,” you receive the entire benefit all at once when you reach a certain date.In “graded vesting,” you receive the benefit in increments, for example, 20% a year for five years until benefits fully vest.Tax status of benefitsThe vesting of a benefit creates tax consequences only if what you receive is itself taxable. For example, employer contributions to a 401(k) plan are generally untaxed, because in a 401(k), you pay taxes only on money you withdraw from your account.
If your employer contributes $100 to your 401(k), it doesn’t matter whether you have full rights to the money immediately or have to wait for that contribution to vest: The money is not taxed, so you don’t report it on your tax return.
On the other hand, if your employer gives you a share of stock, it’s taxable compensation whenever you receive the stock—now, or whenever it vests.
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When taxable benefits are cliff vested, you report the full amount as income in the year you reach the vesting date.When taxable benefits are subject to graded vesting, you report only the value that vested in that year as income.TurboTax Live experts look out for you. Expert help your way: get help as you go, or hand your taxes off. You can talk live to tax experts online for unlimited answers and advice OR, have a dedicated tax expert do your taxes for you, so you can be confident in your tax return. Enjoy up to an additional $20 off when you get started with TurboTax Live.
Reporting benefits as incomeEmployers must report all taxable benefits to their workers on Form W-2. This is the form you get in the mail from your employer telling you how much you earned the previous year and how much was withheld in taxes. Taxable benefits that you received or that vested the previous year will be included in Box 1 of the W-2.
You might receive a separate W-2 specifically for your taxable benefits, or those benefits might be included on the same W-2 as your wage or salary income. Either way, report taxable benefits on your tax return the same way you would your regular wages—on the line marked for wages, salaries, tips, etc. Your employer should have also withheld taxes to cover the benefit. Those taxes will be reported on the W-2, as well.
If your vested benefits are nontaxable, they won’t appear on your W-2, and you have nothing to report on your tax return that year.
Stock options and vestingOne of the most common benefits subject to vesting periods is stock options. A stock option gives you the right to buy company stock at a specific price, called the exercise price or strike price. If the market price of the stock is higher than the strike price when you exercise the option (meaning, when you use the option to buy stock), then you make a profit.
There are two basic types of stock options: incentive options and nonstatutory options. Each gets taxed differently. However, vesting does not create a tax liability with either kind of option. In general:
With incentive options, you are not taxed when the options vest or when you exercise the option. When you sell the stock you bought with the option, you pay capital gains taxes.With nonstatutory options, you also are not taxed when the options vest. When you exercise the option, the difference between the strike price and the market price is taxed as income. When you sell the stock, you pay capital gains taxes.Remember, with TurboTax, we’ll ask you simple questions about your life and help you fill out all the right tax forms. With TurboTax, you can be confident your taxes are done right, from simple to complex tax returns, no matter what your situation.