How Do I Fix TurboTax Double-Counting My ISO Disqualifying Disposition?

Someone on Reddit did an exercise-and-sell with ISOs (a disqualifying disposition). The income from the sale was included in W-2 wages, but the cost basis was not reported correctly on Form 1099-B, so TurboTax is double-counting the income (once from the 1099-B sale and once from the W-2). They need to adjust cost basis so the gain on the sale reflects only the amount not already taxed in W-2, and to document the adjustment. TurboTax does not allow manual editing of Form 8949. The fix: Increase the cost basis on the ISO sale in TurboTax so the reported gain equals only the amount not already in your W-2 (typically basis = FMV at exercise). Override or adjust cost basis in the 1099-B / sale entry, add a reason (e.g., compensation already in W-2), and let TurboTax generate Form 8949 from the corrected data.

Bottom line: For an ISO disqualifying disposition, the spread at exercise is compensation income and is usually already in your W-2. The 1099-B often has wrong (or zero) cost basis, so the gain on the 1099-B is too high and TurboTax ends up taxing the same income twice. Increase the cost basis so reported gain = proceeds minus adjusted basis equals only the gain not already in W-2 (correct basis is usually FMV at exercise). In TurboTax, override or adjust cost basis in the 1099-B / sale flow, enter a reason (e.g., "Compensation from this ISO disqualifying disposition already included in W-2 wages; adjustment prevents double taxation"), and keep copies of your W-2, 1099-B, and explanation.

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Question from Reddit

TurboTax and ISO Disqualifying Disposition - already included in W2 income

Kind of a long shot but hoping someone might have an answer.

I did an "exercise and sell" last year with some ISOs I got from my company, which is taxed on short term basis. This was included in my W2 income and wages, but the cost basis was not captured in my 1099B, so TurboTax is overcalculating my total income, and thus the taxes, since it's counting the income from that sale twice - once on my 1099B and once in my W2.

The answer I've gotten from my brokerage is that I can adjust the cost basis for the ISO sale to include the amount of the sale, since it's already included in my W2 wages. I can indeed do this in TurboTax, however, they also indicated that I need to include a reason for adjusting the cost basis so drastically.

Normally, this would be done on the 8949 form, however, there's not a way to manually edit this form in TurboTax. So what are my options to complete the filing? I've already filed for an extension and made the estimated payment, but I need to file ASAP to avoid any penalties.

Source: Reddit

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Analysis

The user did an exercise-and-sell of ISOs (a disqualifying disposition: sold before holding 1 year from exercise and 2 years from grant). The compensation income (the spread at exercise, or similar amount) was included in W-2 wages, but the 1099-B did not show the correct cost basis, so the broker reported a large gain (or full proceeds as gain). When the user enters the 1099-B into TurboTax, the program adds that gain to income on top of the W-2 amount, so the same income is taxed twice. The fix is to adjust the cost basis on the sale so the reported gain equals only the additional gain (if any) beyond what was already in W-2, and to document the adjustment. TurboTax does not let you manually edit Form 8949, but it usually does let you override or adjust cost basis when entering the 1099-B and add an explanation for the adjustment.

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Answer

What's going on

• For an ISO disqualifying disposition (exercise and sell in the same or short period), the spread (FMV at exercise minus exercise price) is compensation income and is typically included in your W-2. The 1099-B from the broker often shows proceeds and cost basis, but if the broker did not have the correct basis (e.g., they used $0 or the exercise price only), the gain on the 1099-B will be too high. When you enter that 1099-B into TurboTax, the program reports that gain on Schedule D / Form 8949. So you end up with W-2 income (which already includes the compensation from the ISO sale) plus the gain from the 1099-B, i.e., double taxation on the same dollars.

The fix: adjust cost basis

• You increase the cost basis of the shares sold so that the gain reported on the sale equals only the amount that is not already in your W-2. In other words: reported gain = proceeds minus adjusted basis, where adjusted basis is set so that proceeds minus adjusted basis equals the correct gain (only the part that wasn't already wages).
• Example: For the sale, you only want to report additional gain (sale price minus FMV at exercise), not the spread again. So correct basis for the sale = FMV at exercise (so that gain = proceeds minus FMV at exercise = only the appreciation after exercise). If the 1099-B shows basis = 0 or exercise price, then gain is overstated. So you override basis to FMV at exercise (or to whatever produces the correct gain given what's in W-2). The brokerage said "adjust the cost basis to include the amount of the sale"; they likely mean increase basis so that the reported gain is reduced by the amount already in W-2. So adjusted basis = reported basis on 1099-B + amount already included in W-2 from this sale (so that gain on 8949 = proceeds minus adjusted basis = only the part not already taxed). Either way: you're increasing basis so TurboTax doesn't double-count.

What to do in TurboTax

1. Find the 1099-B entry for the ISO sale (e.g., Income → Investments and Savings → Stock options or 1099-B).
2. Override or adjust cost basis: TurboTax usually has an option to override cost basis or to indicate that cost basis is incorrect (e.g., "Cost basis not reported to IRS" or "Adjust cost basis"). Enter the correct basis (the amount that makes gain = proceeds minus that basis equal the gain that is not already in W-2). That may mean entering basis = FMV at exercise for the shares sold, or basis = proceeds minus (gain you want to report), depending on how your W-2 and sale are structured.
3. Add an explanation: When TurboTax asks for a reason or description for the basis adjustment, enter something like: "Cost basis adjusted because compensation from this ISO disqualifying disposition was already included in W-2 wages (Box 1). Adjustment prevents double taxation." Keep it short and clear. The software may put this on Form 8949 in the description column (Code B or similar) or in a statement; even if it doesn't show word-for-word on 8949, having it in the interview helps and you can keep a copy for your records.
4. Form 8949: TurboTax generates Form 8949 from your entries. You don't edit 8949 by hand in TurboTax; you fix the underlying data (the cost basis and the explanation) in the 1099-B / sale section. Once the basis is corrected and the explanation is entered, the printed 8949 should show the correct gain and the code (e.g., B for basis not reported to IRS) with your explanation in the statement or in the description. If your version has a "Statement" or "Additional information" field for the sale, use it for the same explanation.
5. Review: Before filing, confirm that total income = W-2 + only the correct gain from the sale (not the raw 1099-B gain). If the total still looks too high, basis is still too low; increase it until the gain matches what should be taxed once.

Documentation

• Keep copies of: your W-2 (showing the wages that include the ISO compensation), the 1099-B, any Form 3921 (or employer statement) for the exercise, and a short note (or the TurboTax explanation) stating that you adjusted basis because the compensation was already included in W-2. That supports the adjustment if the IRS asks.

If you're still stuck

• Use TurboTax Help (search "adjust cost basis," "1099-B override," "stock option basis") or TurboTax support so they can point you to the exact screen for your product (Desktop vs. Online) and year.
• A tax professional can do the basis adjustment and Form 8949 wording for you and file by your extension deadline so you avoid penalties.

Margen can help you model W-2 + sale so you know the correct gain and basis before you enter them in TurboTax.

Related: Form 3921 and ISO Exercise: What to Enter on Your Return · ISO Sell-to-Cover: Tax Implications · Former Employer Issued Wrong Form 3921: Do I File 1040-X? · Form 83(b) and Restricted Stock Election

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Applicable Sections

Federal / IRS

• ISO disqualifying disposition: When you sell ISO shares before holding 1 year from exercise and 2 years from grant, the spread at exercise is compensation income (often reported on W-2). The gain on sale for capital gains purposes is sale proceeds minus cost basis; for a disqualifying disposition, basis is generally FMV at exercise, so reported gain = proceeds minus FMV at exercise (the appreciation after exercise). If the 1099-B shows wrong basis, you adjust it on Form 8949 and attach an explanation.
• Form 8949: Sales and Other Dispositions of Capital Assets; use Code B (or other code as applicable) when basis is incorrect or not reported to IRS, and attach a statement explaining the adjustment. (IRS Form 8949)
• Publication 525: Taxable and Nontaxable Income; discusses stock options, including ISO disqualifying dispositions. (IRS Publication 525)

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Practical Notes

• Double-count: W-2 already has the compensation; 1099-B had wrong basis, so increase basis so reported gain = only the amount not already in W-2.
• In TurboTax: Override / adjust cost basis in the 1099-B / sale flow; add a reason (e.g., "Compensation from this ISO disqualifying disposition already included in W-2 wages; adjustment prevents double taxation"). You don't edit 8949 by hand; you fix the sale data and the program fills 8949.
• Keep: W-2, 1099-B, Form 3921 (or employer info), and your explanation for the basis adjustment.
• Margen can help you compute the correct gain and basis so you enter the right numbers.
• TurboTax support or a tax pro if you can't find the override or need the return filed by your extension date.

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Limitations

This answer does not cover state treatment of ISO compensation or exact TurboTax menus (which vary by product and year). For your specific W-2 and 1099-B numbers and for filing by your extension deadline, consult a tax professional or TurboTax support. You can use Margen to model the correct income and gain before entering them.