Annual Information Statements and IRS Returns
Requirement to Report
For (1) any exercise of an incentive stock option (ISO) during
2014 or (2) transfer during 2014 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 February 2, 2015, annual information
statements to the participant who exercised the ISO or transferred
the ESPP share; and
- file, by March 2, 2015 (for paper filers) or
by March 31, 2015 (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withdrawn.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, 2015 (or March 31, 2015 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 2014 calendar year in box 1 of the optionee's 2014
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 2014 calendar year, a company must report in box 1 of the
person's 2014 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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