A reader from Washington wonders if stock options should be counted toward earnings when considering Social Security.
“My husband retired in 2015, started Social Security benefits in 2020, and exercised some stock options in 2021 and 2022. We were surprised stock options would count as earnings in 2021 and 2022 as they were part of his compensation package in 2011 and 2012. Can you please confirm if these stock options should be considered earnings in the year exercised and thus cause overpayment of his Social Security benefits in 2022 and 2023?”
Since you mentioned “overpayment” in your question, I feel the earnings test may have come into play due to your husband turning his Social Security benefits on before his Full Retirement Age (FRA). I’m glad you asked this question because it can apply to the many readers who receive compensation through stock options. It also allows me to discuss some fringe issues surrounding the Social Security earnings test.
I went immediately to Social Security’s Program Operations Manual System (POMS), the very detailed and lengthy resource of rules and regulations that Social Security uses to process claims for benefits.
Generally, the earnings test applies to people collecting Social Security benefits before their FRA and still working. You can receive a certain amount in the same year as you’re receiving Social Security benefits without those benefits being affected. If you earn more than that amount – and the amount changes every year – they will start reducing your benefits by $1 for every $2 over the limit or $1 for every $3 over the limit, depending on the year and other details. The month you reach your FRA, there is a hard stop on applying the earnings test. It simply goes away. (For more information, we have covered exactly how the earnings test works in great detail in other blog postings on our site.)
The general rule regarding what earnings count toward the earnings test includes “earnings from work” done in the year you’re collecting the Social Security benefit. That description applies over 95% of the time, with very few exceptions. To clarify further: money from investing, buying and selling stock options, stocks or bonds, taking distributions from your retirement account, or earning interest from your bank are not “earnings from work” and will not be considered earnings for purposes of the earnings test.
Now, people earn many forms of compensation while working that don’t come in the traditional form of W-2 wages or self-employment income. This compensation would also count toward the earnings test, but only if you’re employed or doing the work in the year you have those Social Security benefits paid to you.
POMS lists less common income sources and indicates whether 88 specific types of remuneration should be treated as earnings and count toward the earnings test. It includes stock options granted to you as part of employment, so I wanted to get you a definitive answer. To access the source material, search online for “Social Security POMS.” Go to subchapter RS02505.240 entitled “Summary of How Major Types of Remuneration Are Treated.”
Number 73 on that page is “Stock Option Plan.” Here is the exact text:
“Count as wages the difference between the fair market value of stock at the time the option is exercised and the option price. Count these in the period the option was granted. Granted (e.g., the wage earner receives a W-2 for the sale of stock, but was granted the stock option earlier in their career. We count wages in the period the stock option was granted). (IRS Ruling 56-452) (RS 01401.340)”
That’s my interpretation of what you were asking. Your husband was granted options in 2011 and 2012 while working for a company. He held onto those stock options until 2021 and 2022, when he exercised them. Like many forms of remuneration, it is tied to when you earn it and not when you are paid. So those options just sat there with no benefit to your husband.
Then he decided to exercise the options, and the fair market value (the current value of the stock) was higher than the options price, so he made a profit, which was reported. It seems he received a notice that he was overpaid Social Security benefits due to the earnings test. If so, Social Security may have scraped the income into his earnings for the earnings test calculation.
I don’t have access to your complete situation, so I don’t know what other earnings might be there. Exercising the stock options may not even be the issue. However, if this is indeed what is pushing your husband over the earnings limit, those proceeds should not be counted. He should immediately reach out to Social Security and appeal their application of the earnings test.
As long as he can provide information that those options were granted back in 2011 and 2012 while he was working, that’s when they would have essentially looked to apply those earnings. They’re backdating them, so your 2021 and 2022 “earnings from work” would not be affected by him exercising those stock options in those later years.
Examples of other situations where timing applies include sick leave or bonuses you receive. Say you stop working at the end of the calendar year, but your bonus isn’t paid out until January or February. Social Security will ignore those for the earnings test, too. They’ll say, “No, you earned these last year. However, because you got paid this year, they will go in this year’s tax return, but they will be removed for purposes of the earnings test.”
Because of how earnings are reported, Social Security may not pick up on that detail automatically. It will have to be pointed out with some supporting documentation.
I think your husband is in good shape. The frustrating part is that Social Security will default to their opinion and apply the proceeds to earned income, so he’ll have to appeal it. Once he points out they were stock options granted long ago but exercised recently, Social Security will realize the earnings test should not have been triggered. When they determine he is right – and I believe they will, based on what you told me – they will make him whole for any benefits withheld to compensate for what was initially calculated as an “overpayment” of benefits.