By Christine
McCarthy and Michael
Yang
Annual
Information Statements and IRS Returns
Requirement
to Report
For any exercise of an
incentive stock option (ISO) or transfer of a share previously purchased
pursuant to a tax-qualified employee stock purchase plan (ESPP) where the
purchase price paid for the share was (a) less than 100% of the fair market
value on the date of grant or (b) not fixed or determinable on the date of
grant, the Internal Revenue Code requires companies to:
- furnish, by January 31,
2014, annual information statements to the participant who
exercised the ISO or transferred the ESPP share; and
- file, by February 28,
2014 (for paper filers) or by March 31, 2014 (for
electronic filers), an information return with the IRS (please note
that companies may request an automatic 30-day extension of this
deadline by filing a Form
8809, Application for Automatic Extension of Time to File
Information Returns, with the IRS on or before the applicable filing
deadline).
With respect to reporting
ESPP transactions, companies are required to report the first transfer of
legal title to any share purchased under an ESPP plan. When a participant's
shares are put into a brokerage account on behalf of such participant, the
transaction is considered a transfer of legal title and, if it is the first
transfer of legal title of the shares, it must be reported to the IRS and
to the participant. If instead a participant's shares are issued directly
to the participant or registered in the participant's name on the company's
records, the transaction does not need to be reported to the IRS or to the
participant because such transaction is not considered a transfer of legal
title.
Participant information
statements may either be delivered or mailed to the participant's last
known address or, if the participant has given his or her consent to
receive the statement electronically, provided in electronic format. The
consent to receive the statement electronically must be made in a way that
demonstrates that the participant can access the statement in the
electronic format in which the statement will be provided. For example, if
the statement will be sent as a Word attachment to an e-mail message, the
consent also must be sent as a Word attachment to an e-mail message.
Further, the participant must be provided with certain disclosures related
to the consent, including the right to receive a paper copy and the manner
in which consent may be withdrawn.
Format of
Statement/Return
Returns for ISO and ESPP
transactions must be submitted to the IRS on Form 3921 (for ISOs)
and Form 3922 (for
ESPPs). You may order Form 3921 and/or 3922 by calling the IRS at
1-800-829-3676 or through the IRS website
(please note that, even though Forms 3921 and 3922 may be found on the IRS
website, you are not permitted to print and file these forms with the IRS;
the IRS will only accept the official forms ordered from the
IRS).
Participant statements may be
provided on Form 3921 (for ISOs) and Form 3922 (for ESPPs) or may be
provided using a different format that complies with the substitute form
requirements found in IRS
Publication 1179. At a minimum, substitute forms will need to
contain all of the same information as the actual Form 3921 and 3922.
We expect that companies with
a limited number of transactions will likely use Forms 3921 and/or 3922 (as
opposed to substitute statements) since these forms will need to be
prepared and submitted to the IRS in any event. Further, we expect
that companies that provide Form 3921 and/or 3922 to participants (again,
as opposed to providing substitute statements) will deliver the form(s) to
their participants, along with a cover letter explaining the statement in a
manner similar to this
statement for ISO transactions and this
statement for ESPP transactions.
The IRS requires that a
separate Form 3921 or Form 3922 as applicable be filed with the IRS for
each transaction (i.e., each ISO exercise), even if one participant
has multiple transactions during the course of the year. If a company
provides participants with an information statement that meets the
substitute statement requirements, the IRS has indicated that the company
may aggregate transactions and provide only one substitute statement to
each participant who had multiple transactions during the year.
Whether you use Forms 3921
and/or 3922, or you use substitute forms, certain information must be
included in the form, including for ESPP transactions, the price per share
of ESPP stock transfers. If the exercise price is not fixed or determinable
on the date of grant (e.g., the exercise price is the lesser of 85%
of the fair market value on the first day of an offering period or 85% of
the fair market value on the last day of an offering period), you must
report the exercise price as if the purchase occurred on the grant date (i.e.,
the first day of the offering period). In addition, if any individual
participant has more than one ISO transaction or more than one ESPP
transaction in a calendar year, you must include a unique account number on
the form. The IRS has indicated that this number may be any number,
not longer than 20 digits, and can contain numbers, letters and special
characters. The unique number assigned to exercises/purchases by some
stock plan administration programs could be used for this purpose.
Otherwise, you should create a system to assign numbers to each
transaction. Finally, even though you are only required to assign
unique account numbers if a participant has more than one ISO or ESPP
transaction in a year, we recommend that you assign a number to every ISO
and ESPP transaction, as we expect that this will be used by the IRS to
track/locate transactions and will likely be easier to ensure compliance if
it is done consistently for all transactions.
Electronic Submission of
IRS Returns
Companies that are required
to file 250 or more ISO returns or 250 or more ESPP returns to the IRS must
file the ISO or ESPP returns, as applicable, electronically through the
IRS' Filing Information Returns Electronically (FIRE) system. To
submit through the FIRE system, you will need to set up a FIRE account
through the IRS website and you will need a Transmitter Control Code (TCC).
If you are using a stock plan administration firm that will be submitting
these returns on the company's behalf, they will likely use their
TCC. If you are not filing through a stock plan administration firm
and/or do not have a TCC, you will have to submit a Form 4419, Application
for Filing Information Returns Electronically, so that a TCC can be
assigned to the company. Form 4419 must be submitted to the IRS at least 30
days prior to filing a return electronically, and thus, must be submitted
no later than March 1, 2014 (or March 31, 2014 if an
extension is obtained) in order to timely file Forms 3921 or 3922
electronically. Also, to submit returns through FIRE, you will need to
create a submission file that meets the FIRE requirements. These formatting
requirements for FIRE are somewhat onerous and, as a result, companies will
likely need assistance in creating the submission file due to the
formatting requirements (a number of stock plan administration firms are
equipped to provide this assistance). In addition, while you are
permitted to voluntarily file electronically, because the process is
challenging and potentially involves some cost to prepare the necessary
file, most companies with limited transactions will find it more practical
to prepare and file paper returns.
Penalties
The Internal Revenue Code
imposes up to a US$100 penalty for each statement not furnished, or for
each statement furnished to a participant with incomplete or incorrect
information, up to a maximum penalty of US$1,500,000 per year. In addition,
the Internal Revenue Code imposes up to a US$100 penalty for each return
not filed with the IRS, or for each return filed with the IRS with
incomplete or incorrect information, up to a maximum penalty of
US$1,500,000 per year. Greater penalties will apply if a company
intentionally fails to provide a statement or file a return with the IRS.
Assistance
Please contact any member of
Orrick's Compensation and Benefits Group for further assistance on meeting
these information statement and return requirements. If you use an
external stock plan administrator, your stock plan administrator may also
be of assistance as many stock plan administrators have developed specific
services to help companies comply with these
requirements.
Additional Annual Reporting Requirements
Disqualifying
Disposition of ISO Shares
A company must report any
ordinary income that an optionee recognizes in connection with a
disqualifying disposition of ISO shares during the 2013 calendar year in
box 1 of the optionee's 2013 Form W-2. Failure to report this income will
prevent a company from taking a deduction for the ordinary income that
results from the disqualifying disposition and may subject the company to
certain reporting penalties.
A sale of ISO shares before
the later of the date which is two years after the date of grant and the
date that is one year after the date of exercise is treated as a
disqualifying disposition. The ordinary income recognized on a
disqualifying disposition is equal to the difference between the ISO
exercise price and the lesser of the fair market value of the shares
on the date of exercise or the sale price of the shares.
Disposition of ESPP
Stock
If any person transferred
ESPP stock for the first time during the 2013 calendar year, a company must
report in box 1 of the person's 2013 Form W-2 the amount of the purchase
price discount (described below), if any, on ESPP stock and, if the ESPP
stock was transferred in a disqualifying disposition, any ordinary income
that the person recognized when the shares were transferred. The
"purchase price discount" is the difference between the fair
market value of the shares on the first day of the offering period and the
purchase price that would result if the shares were actually purchased on
the first day of the offering period. For example, if the purchase price of
the ESPP stock is equal to the lesser of 85% of the fair market value on
the first day of the offering period and 85% of the fair market value on
the last day of the offering period (the purchase date), the purchase price
discount is 15% of the fair market value on the first day of the offering
period. Failure to report this income will prevent a company from taking a
deduction for the ordinary income and may subject the company to certain
reporting penalties.
A transfer of ESPP stock
before the later of the date which is two years after the first day of the
offering period or the date which is one year after the purchase date
is treated as a disqualifying disposition. The ordinary income recognized
on a disqualifying disposition is equal to the difference between the
purchase price and the fair market value of the shares on the purchase
date.
If you would like additional
information on the topic discussed in this Compensation
and Benefits Alert, please contact any member of Orrick's Compensation
and Benefits Group.
Orrick's Compensation and
Benefits Team
|