He Exercised $180,000 in Stock Options After Retiring at 64. His W-2 Said Wages. Social Security Said Prior Work.

Picture a technology worker who gets caught in layoffs at 64, files for Social Security and then exercises nonqualified stock options his employer granted years earlier. The spread between the exercise price and the stock’s market value is $180,000. Then the W-2 arrives. The $180,000 is sitting there as wages.

That looks disastrous for someone collecting Social Security before full retirement age (FRA). In 2026, the retirement earnings test limit for someone under FRA all year is $24,480, with $1 in benefits withheld for every $2 of earnings above it. If Social Security treated the entire $180,000 as current earnings, the apparent excess would be $155,520, enough to trigger as much as $77,760 of withholding.

Except the W-2 does not get the last word.

Social Security Has a Specific Rule for Stock Options

For tax purposes, exercising a nonqualified stock option generally produces compensation equal to the difference between the stock’s fair market value and the exercise price. An employer generally reports that spread on Form W-2, including in Box 1 and, subject to the applicable limits, the Social Security and Medicare wage boxes. The Social Security earnings test asks a different question: When should those wages count?

The Social Security Administration’s (SSA’s) own operating manual specifically addresses stock-option plans. It says to count the option spread as wages in the period when the option was granted, even when the worker receives the W-2 after exercising it later in his career. So if these options were granted years before he retired, the $180,000 does not suddenly become $180,000 of post-retirement work merely because he exercised them at 64. That is the reversal.

The Same Principle Covers Other Late Paychecks

Social Security calls certain compensation received after retirement for earlier work “special payments.” Examples include bonuses, accumulated vacation or sick pay, severance, back pay and sales commissions. Deferred compensation reported on a W-2 in one year but earned earlier can qualify as well. These payments usually do not affect retirement benefits when they are attributable to work done before retirement.

The mechanics are not identical for every type of payment. Stock options have their own rule tying the wages to the grant period. Vacation pay, bonuses and deferred compensation have separate rules governing when they are considered earned. The common thread is that payment date and earnings-test date are not always the same date.

The Paperwork Can Still Cause Trouble

That does not mean the process is automatic. Social Security has a specific employer report, Form SSA-131, for special wage payments. It allows an employer to identify wages paid during the current tax year that relate to prior years or were paid on account of retirement. SSA also has procedures for contacting an employer or beneficiary when special-payment information is needed to correct earnings used for the test.

That makes the paper trail important. Before leaving, the worker should keep the stock-option grant agreement, vesting records, exercise statement, termination paperwork and W-2. If Social Security initially treats the $180,000 as current earnings, those documents help establish when the compensation belongs for earnings-test purposes. The W-2 is evidence of wages. It is not necessarily evidence of when those wages count.

The Tax Bill Does Not Disappear

There is one more twist. Excluding the option spread from the current-year earnings test does not erase its tax consequences. The compensation still enters his tax return. That additional income can cause a larger share of his Social Security benefits to become federally taxable. The IRS determines benefit taxation using other income plus one-half of Social Security benefits, and at higher income levels as much as 85% of benefits can be included in taxable income.

The option spread may also remain subject to Social Security payroll tax up to the 2026 taxable wage base of $184,500 and Medicare tax without that wage cap. So he can win the Social Security earnings-test argument and still owe a sizable tax bill. That is why the distinction matters. The IRS can call $180,000 wages this year. Social Security can look at those same dollars and ask a different question entirely: When did you earn the right to them?

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