Annual
Reporting Requirements for Incentive Stock Options and Employee Stock
Purchase Plans
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, 2012, annual information statements to the
participant who exercised the ISO or transferred the ESPP share; and
- file,
by February 28, 2012 (for paper filers) or by April 2,
2012 (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 new 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, 2012 (or March 31, 2012 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 new
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 2011 calendar year
in box 1 of the optionee's 2011 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 2011 calendar year,
a company must report in box 1 of the person's 2011 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
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