ESPP Taxes Explained: Form 3922, Qualifying vs. Disqualifying Dispositions, and the Cost-Basis Trap on Form 1099-B

Some U.S. employers offer an ESPP (Employee Stock Purchase Plan), which lets you buy company stock at a discount through payroll deductions. The discount is attractive, but the tax rules when you sell are different from those for RSUs or ordinary shares.

The biggest trap is the cost basis on the Form 1099-B from your broker. In many cases it leaves out the discount that was already taxed as wages, so if you report the sale as shown, you pay tax twice on the same income. Based on IRS Publication 525 and the instructions for Forms 3922 and 8949, this guide explains how ESPP sales are taxed, with a worked example.

It also covers what changes if you sell after moving back to Japan. If you sold ESPP shares in 2026 or plan to, use this to prepare for your return.

Key points

• Shares bought through a tax-qualified (Section 423) ESPP are not taxed when you buy them (exercise the option). They are taxed in the year you sell.
• In a qualifying disposition (sold more than 2 years after the grant date and more than 1 year after purchase), ordinary income is limited to the lesser of the discount at grant or your actual gain. The rest is long-term capital gain.
• In a disqualifying disposition (holding period not met), ordinary income equals the stock’s value on the purchase date minus the price you paid, even if you sold for less or at a loss.
• This ordinary income is included in W-2 Box 1, but it is not subject to Social Security or Medicare tax, and income tax withholding is not required.
• For options granted after 2013, the basis on Form 1099-B does not include the ordinary income. You must adjust it on Form 8949 (code B) or you will be taxed twice.

How an ESPP works: key terms

During an offering period, money is deducted from your pay, and on the purchase date it buys company stock. For tax purposes, your employer grants you an option to buy stock, and you exercise the option on the purchase date.

• Grant date: the date the option is granted.
• Exercise (purchase) date: the date the option is exercised and shares are bought. Your holding period starts the day after.
• Option price: the per-share price you actually pay. Some plans base it on the lower of the stock price on the grant date or the purchase date.
• Fair market value (FMV): the stock’s value on the grant date and on the purchase date, which drive the tax calculation.

Publication 525 explains that to get statutory option treatment, you generally must be an employee of the company (or a related company) from the grant date until 3 months before you exercise. The timing and amount of payroll deductions do not affect your basis.

Reading Form 3922

If the ESPP purchase price is less than 100% of the stock’s value on the grant date (or is not fixed on that date), the company must file Form 3922 for each first transfer of legal title of the shares made during the year, and give you a copy. Here is what each box shows:

Box	What it shows	Used for
Box 1	Date option granted	Qualifying-disposition test (2 years from grant)
Box 2	Date option exercised (purchase date)	Qualifying test (1 year from purchase); short- vs. long-term
Box 3	FMV per share on grant date	Ordinary income in a qualifying disposition
Box 4	FMV per share on exercise date	Ordinary income in a disqualifying disposition
Box 5	Exercise price paid per share	Starting point for basis
Box 6	Number of shares transferred	Matching to the shares you sold
Box 7	Date legal title transferred	Records
Box 8	Exercise price per share as if exercised on the grant date (only if the price was not fixed on that date)	Ordinary income in a qualifying disposition

You do not attach Form 3922 to your return, but you need it to figure your tax when you sell, so keep each one. The IRS instructions also say Form 3922 is not required for a nonresident alien employee who was not required to receive a Form W-2 from the year of grant through the year of the first transfer.

Qualifying vs. disqualifying dispositions

Your tax depends on whether you meet the holding period. Publication 525 says you meet it if you do not sell until after the later of 2 years from the grant date and 1 year from the date the shares were transferred to you.

Item	Qualifying disposition	Disqualifying disposition
Holding period	More than 2 years from grant and 1 year from purchase	Requirement not met
Ordinary income (wages)	Lesser of (1) FMV at grant minus the option price (figured as if exercised at grant), or (2) sale price minus the price you paid	FMV on the purchase date minus the price paid, regardless of your gain or loss
If you sell at a loss	No ordinary income; the loss is a capital loss	Ordinary income still applies; the loss is a capital loss
Basis	Price paid + ordinary income	Price paid + ordinary income
Capital gain type	Long-term	Short-term if sold within 1 year of the day after purchase; otherwise long-term

Either way, your employer (or former employer) should report the ordinary income as wages in Box 1 of your W-2. If it is not on your W-2, you still must report it as wages on your return.

Worked example: same shares, different tax

Example (hypothetical): You buy 100 shares. FMV on the grant date is $100 and on the purchase date $120. The plan lets you buy at 85% of the lower of the two prices, so the option price is $85 ($100 × 85%) and you pay $8,500. The price as if exercised on the grant date (Form 3922, Box 8) is also $85.

Case	Sale	Ordinary income (W-2 Box 1)	Adjusted basis	Capital gain (loss)
1	Sold 6 months after purchase at $130 (disqualifying)	$3,500 ((120 − 85) × 100)	$12,000	+$1,000 (short-term)
2	Holding period met, sold at $130 (qualifying)	$1,500 (lesser of (100 − 85) × 100 and (130 − 85) × 100)	$10,000	+$3,000 (long-term)
3	Holding period met, sold at $80 (qualifying)	$0 (sold at a loss)	$8,500	−$500 (long-term)
4	Sold 6 months after purchase at $90 (disqualifying)	$3,500 (regardless of the loss)	$12,000	−$3,000 (short-term)

Cases 1 and 2 both bring in $13,000 and the same total gain of $4,500. What differs is how much is taxed as wages and whether the capital gain is short- or long-term. In Case 4, the stock fell after purchase, yet the $3,500 of ordinary income remains and the $3,000 drop is a capital loss.

The Form 1099-B basis trap and how to fix it on Form 8949

Your broker’s Form 1099-B shows sale proceeds and cost basis. But according to Publication 525 and the Form 8949 instructions, for options granted on or after January 1, 2014, the basis on Form 1099-B won’t reflect any amount you included in income at grant or exercise. In the example, the 1099-B basis stays at the $8,500 you paid.

Case	Reported with 1099-B basis	Correct reporting	Result of the error
1	$4,500 gain	$1,000 gain ($3,500 already taxed on W-2)	$3,500 taxed twice
2	$4,500 gain	$3,000 gain ($1,500 already taxed on W-2)	$1,500 taxed twice
4	$500 gain	$3,000 loss	$3,000 loss missed and $500 gain reported

The IRS says making the adjustment is your responsibility. On Form 8949:

1. For sales where the 1099-B shows basis was reported to the IRS (for example, box A or D on Form 8949), enter the 1099-B basis in column (e), code B in column (f), and the adjustment (the ordinary income) in column (g).
2. For sales where basis was not reported to the IRS (for example, box B or E), enter the correct basis in column (e), code B in column (f), and 0 in column (g).
3. Confirm the ordinary income amount, which should be in W-2 Box 1, using your pay records or your employer’s equity statements.

For options granted before 2014, the 1099-B basis may or may not include the ordinary income, so check each lot.

How ESPP income shows up on your W-2

Under Publication 15-B, pay from exercising an ESPP option or selling the shares is not wages for Social Security, Medicare (FICA), or FUTA tax. Federal income tax withholding is also not required on income from a disqualifying disposition or on the discount portion in a qualifying disposition. Your employer still reports this ordinary income in W-2 Box 1.

Because tax usually is not withheld on ESPP income, you may owe more when you file for the year of sale. If the amount is large, consider estimated tax payments or adjusting your Form W-4. By contrast, income from exercising nonstatutory stock options (NSOs) is reported in Box 12 with code V and is subject to Social Security and Medicare tax.

Selling after you move back to Japan

The U.S. side

If you are a nonresident alien (a Japan resident) when you sell, Publication 519 says gain from selling personal property is generally sourced by your tax home, and is foreign-source if you have no U.S. tax home. A nonresident alien’s U.S.-source capital gains are taxed at 30% (or a lower treaty rate) if the person was in the United States for 183 days or more during the year. So the capital gain portion of an ESPP sale after you move back often is not taxed in the U.S.

The ordinary income portion needs more care. It is pay for services, and Publication 519 sources multiyear compensation on a time basis: by the share of workdays in the United States during the period the compensation relates to. If you received and bought ESPP shares while working in the U.S. and sell after returning, some or all of the ordinary income may be U.S.-source income that must be reported on Form 1040-NR.

U.S. citizens and green card holders are taxed on worldwide income even while living in Japan. Your move-back year may also be a dual-status year, part resident and part nonresident.

The Japan side

Japanese residents (other than non-permanent residents) are taxed on worldwide income. Shares traded on a foreign exchange count as listed shares (上場株式等), and gains are taxed separately at 20% (15% national income tax and 5% resident tax), plus reconstruction special income tax of 2.1% of the income tax. The NTA’s Q&A says that when you sell foreign shares in foreign currency, the yen equivalent of the proceeds is the sales amount, and currency gains or losses are not split out as separate income.

Japan’s view of the cost of ESPP shares may not match your adjusted U.S. basis. Before you move, gather records showing purchase dates, prices, values, and exchange rates (Forms 3922, purchase confirmations, W-2s). For claiming a foreign tax credit when both countries tax the same income, see the related articles.

FAQ

Do I report anything in the year I buy ESPP shares?

Publication 525 says you do not include any amount in income when a statutory option is granted or exercised. Generally nothing is taxed until you sell, but keep Form 3922 because you will need it then.

Why doesn’t my 1099-B basis equal what I paid plus the W-2 income?

For options granted after 2013, the 1099-B basis does not include the ordinary income already taxed as wages. Adjust it on Form 8949 with code B.

Is ESPP income subject to Social Security tax?

No. Under Publication 15-B, pay from exercising an ESPP option or selling the shares is not wages for Social Security, Medicare, or FUTA tax.

What if I sell after leaving the company?

Publication 525 says your employer or former employer should report the ordinary income in W-2 Box 1. Check any W-2 you receive from your former employer for the year of sale.

At CLT NY INC., an IRS Enrolled Agent helps with returns that include ESPP, RSU, and other equity pay, and with filings around your move back to Japan, in Japanese or English. Contact us.

Related articles

• Decoding RSU and Stock Option (ISO/NSO) Taxation: Understanding the Critical Differences in Vesting and Sale Tax Events
• The Definitive Guide to RSU & Stock Option Taxation for Tech Employees: From Vesting to Sale, and Preventing Double Taxation
• US Stock and Cryptocurrency Capital Loss Carryover Rules: Leveraging the Annual $3,000 Deduction for Tax Savings
• Pre-Departure Checklist: What to Confirm Before Closing Your US Bank, Brokerage, and 401(k) Accounts
• Expat’s Essential Guide: Navigating Dual-Status Tax Filing for US Arrival & Departure Years
• Filing Your Japanese Tax Return After Returning from the U.S.: How to Report U.S. Salary, Stocks, and Rental Income and Claim the Foreign Tax Credit

Sources: IRS, Publication 525 (2025), Taxable and Nontaxable Income; IRS, Instructions for Forms 3921 and 3922 (04/2025); IRS, Instructions for Form 8949 (2025); IRS, Publication 15-B (2026); IRS, Publication 519 (2025), U.S. Tax Guide for Aliens; National Tax Agency of Japan, Tax Answer No.1463; NTA, Tax Answer No.2010; NTA, Q&A on gains from foreign-currency stock sales. Information as of October 2026. This article provides general information and is not individual tax advice.