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Navigating the Wash Sale Rule in Equity Compensation Planning

July 5, 2023 by Parkside Advisors

Are you considering selling shares acquired through your employer’s equity compensation plan?  You should be aware of the wash sale rule that can present challenges when selling shares at a loss.

Background

If you receive equity compensation from your employer your shares may have unrealized capital losses, i.e., the current value is less than the value at which the shares were acquired.  You may be interested in selling some of your position to recognize the tax benefit from capital losses, but you should be careful to consider the Internal Revenue Code’s wash sale rule.

What causes a Wash Sale?

The wash sale rule is designed to prevent taxpayers from creating artificial tax losses by selling a security at a loss, only to reacquire the same or a substantially identical security within a specified period.

The rule provided that a wash sale occurs when you sell a security at a loss and reacquire the same security (or a substantially identical one) within 30 days before or after the sale. The loss is disallowed for tax purposes and deferred until a future sale of the security occurs.

To illustrate the concept, let us assume you sell a stock for $80 that was originally purchased for $100. A week after the sale, you repurchase the same stock for $85. Because the repurchase occurred within 30 days of the sale, the wash sale rule applies: instead of recognizing a $20 capital loss at the time of the sale, the $20 loss is added to the cost basis of the repurchased stock, giving it an adjusted basis of $105.  If this repurchased stock is subsequently sold for $85 at a future date, there would be a $20 capital loss recognized at that time.

The Issue with the Wash Sale Rule and Equity Compensation Plans

The wash sale rule can be difficult to navigate for employees who receive equity compensation since the wash sale rule applies to shares acquired through any method, including restricted stock unit (“RSU”) and performance stock unit vesting, employee stock purchase plan acquisitions, and exercises of nonqualified and incentive stock options.

Consider an employee who wants to sell her underwater holdings to recognize a loss for the tax benefit, but whose RSUs are vesting quarterly throughout the year.  If her shares are sold for a loss within 30 days of an RSU vesting date, the wash sale rule will apply to the transaction and negate the current benefit of the loss to a portion or potentially all of the shares sold.

The wash sale rule is applied based on the number of shares reacquired within the 30-day window before or after a loss transaction. For example, if an employee sells 100 shares at a loss on June 15th and subsequently vests in 40 RSUs on July 1st, the wash sale rule would apply to 40 of the shares sold. The employee can recognize a capital loss for the other 60 shares sold, assuming no other acquisitions occur within 30 days.

The wash sale rule applies to transactions in any account owned by an employee.  Some stock plan administrators now report wash sales in the employee’s account but do not track the information across the employee’s outside accounts.  Employees can inadvertently trigger a wash sale by selling the stock at a loss in one account while buying the same stock (including vesting or exercising) within 30 days in their employee account.  This includes retirement accounts.  Employees have the responsibility to track wash sales across all of their accounts as part of their income tax reporting obligation.

Conclusion

Understanding the wash sale rule can avoid an unpleasant surprise at tax filing time.

Robust tax planning for employee equity compensation plans should consider all available opportunities and limitations, such as wash sale avoidance, multiple forms of equity compensation and vesting schedules, trading period restrictions, 10b5-1 trading plans, and option expiration dates, to name a few.

If you have questions about the wash sale rule or equity compensation planning for your specific situation, please contact Parkside Advisors.

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Filed Under: Tax Planning

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