Equity compensation, such as Incentive Stock Options (ISOs), has become a cornerstone of the compensation strategy for many startups. While these options offer a range of benefits for both employers and employees, they also come with specific tax obligations and reporting requirements. Enter IRS Form 3921—a critical form that serves as the linchpin for reporting ISO exercises to the Internal Revenue Service.
This form not only aids the IRS in ensuring tax compliance but also helps employees keep track of essential information required for their own tax returns.
What Is the Purpose of IRS Form 3921?
The purpose of IRS Form 3921 is to inform the IRS of the exercise of an incentive stock option (ISO). ISOs are a type of equity compensation that allows employees to purchase company stock at a predetermined price, typically below the fair market value of the stock. When an employee exercises an ISO, they are essentially buying stock from their employer.
Form 3921 provides the IRS with information about the ISO exercise, such as the date the option was exercised, the exercise price, and the fair market value of the stock. This information helps the IRS track the number of ISOs that are exercised and the amount of compensation that is received by employees.
The IRS uses this information to ensure that employees pay the correct amount of taxes on the appreciation in the value of the stock. If an employee sells the stock within one year of the exercise date, they will owe ordinary income taxes on the entire amount of the appreciation. However, if they hold the stock for at least one year from the date the option was granted and two years from the date the option was exercised, they will only owe capital gains taxes on the appreciation.
In addition to informing the IRS of the exercise of an ISO, Form 3921 also serves as a record for the employee. The employee should keep a copy of Form 3921 for their own records so that they can properly report the income on their tax return.
Related resource: IRS- About Form 3921, Exercise of an Incentive Stock Option Under Section 422(b)
The Difference Between Form 1099B and Form 3921
The main difference between the two forms is that Form 1099-B reports on the sale of stock, while Form 3921 reports on the exercise of an ISO. Form 1099-B is typically filed by the brokerage firm that sold the stock, while Form 3921 is typically filed by the startup that issued the ISO.
- Form 1099-B is an information return that must be filed by brokers and other financial institutions to report the proceeds of sales and other taxable transactions in securities, such as stocks, bonds, and mutual funds. The form provides the IRS with information about the sale, such as the date of the sale, the sale price, and the cost basis.
- Form 3921 is an information return that must be filed by startups with the IRS when an employee exercises an incentive stock option (ISO). The form provides the IRS with information about the ISO exercise, such as the date the option was exercised, the exercise price, and the fair market value of the stock.
“If you sold stock, bonds or other securities through a broker or had a barter exchange transaction (exchanged property or services rather than paying cash), you will likely receive a Form 1099-B. Regardless of whether you had a gain, loss, or broke even, you must report these transactions on your tax return.” HRBlock
Related resource: What is a Schedule K-1: A Comprehensive Guide
How Does Form 3921 Impact Employees Who Exercise an Incentive Stock Option (ISO)?
- It provides the IRS with information about the ISO exercise, which the IRS uses to ensure that employees pay the correct amount of taxes on the appreciation in the value of the stock.
- It serves as a record for the employee, which they can use to properly report the income on their tax return.
If an employee sells the stock within one year of the exercise date, they will owe ordinary income taxes on the entire amount of the appreciation. However, if they hold the stock for at least one year from the date the option was granted and two years from the date the option was exercised, they will only owe capital gains taxes on the appreciation.
The employee should keep a copy of Form 3921 for their own records so that they can properly report the income on their tax return.
When Should a Startup Owner Receive a Form 3921?
For startup owners, Form 3921 is their responsibility. Whenever an employee exercises ISOs granted by the startup, the owner must provide them with Form 3921.
To ensure timely filing of Form 3921, keep in mind these three crucial deadlines:
- January 31: The final date to distribute copy B to all employees who exercised their ISOs during the preceding year.
- February 28: The cut-off for submitting copy A to the IRS via paper forms.
- March 31: The last date to send copy A to the IRS through electronic submission.
What Information Do You Need to Complete the Form?
Filling out Form 3921 requires particular attention to details and collecting specific data. It’s crucial to identify the necessary information for startup owners and employees.
You can find more information about Form 3921 on the IRS website.
For Startup Owners
Startup owners provide Form 3921’s data set so they must provide:
- The name, address, and taxpayer identification number (TIN) of the employee who exercised the ISO.
- The date the ISO was granted.
- The exercise price of the ISO.
- The fair market value of the stock on the date the ISO was exercised.
- The number of shares of stock that were acquired through the exercise of the ISO.
- The name and TIN of the company that issued the ISO.
- The transmitter control code (TCC), if filing electronically.
- The employee’s email address, if filing electronically.
- The fair market value of the stock on the date of exercise, if the employee did not hold the stock for at least one year from the date the option was granted and two years from the date the option was exercised.
- The company’s EIN (Employer Identification Number)
The company can obtain the employee’s TIN from the employee’s W-4 form. The company can obtain the fair market value of the stock from the stockbroker or transfer agent. The company can obtain the transmitter control code from the IRS website.
The company must file Form 3921 by March 31 of the year following the year in which the ISO was exercised. The company can file Form 3921 electronically or by mail.
For Startup Employees
Employees do not need to complete Form 3921. This form is filed by the company that issued the incentive stock option (ISO). However, the employee may need to provide some information to the company, such as their taxpayer identification number (TIN).
The employee’s TIN can be found on their W-4 form. The company can use this information to complete Form 3921.
The employee should also keep a copy of Form 3921 for their own records. This could be helpful if they ever need to file an amended tax return or if the IRS audits them.
Do Startups or Employees Owe Taxes on Form 3921?
The employee will owe taxes on the difference between the fair market value of the stock on the date the option was exercised and the exercise price when they sell the stock, unless they hold the stock for at least one year from the date the option was granted and two years from the date the option was exercised. In that case, the employee will not owe any taxes on the appreciation in the value of the stock.
The startup does not owe any taxes on the exercise of an ISO. However, if the startup later sells the stock that was acquired through the exercise of the ISO, it may owe capital gains taxes on the appreciation in the value of the stock.
How to File IRS Form 3921 as a Startup Owner
Yearly tax reporting is a ritual, and for those with ISO dealings, Form 3921 is a significant part of this process. Here’s a breakdown:
1. File Copy A Through the IRS
Form 3921 can be submitted to the IRS electronically or via traditional mail. Online methods are often more efficient and can offer faster confirmations of receipt. Regardless of your choice, ensure you’re ahead of the filing deadline, which typically aligns with other wage and tax statements.
2. Give Copy B to the Employee
This isn’t just a courtesy; it’s a requirement. Distributing Copy B of Form 3921 ensures that employees have the essential data they need to file their taxes correctly. The timeline is tight, with the document typically due to the employee by January 31st of the year following the ISO exercise.
3. Keep Copy C for Startup Records
In the world of business, documentation is king. Keeping Copy C of Form 3921 is not just good practice but vital for tax compliance. If the IRS ever comes knocking with an audit in tow, you’ll be grateful you retained these records.
What Happens if You Miss the Filing Deadline?
Oversights happen, but missing the Form 3921 deadline can be costly. Penalties can accrue, and these, over time, can become substantial financial burdens. If you realize you’ve missed the deadline, it’s crucial to act promptly: submit the form as soon as possible and consult a tax professional regarding any penalties and potential relief.
The amount of the penalty will depend on how late you file the form and whether you have a history of filing late.
The IRS may impose a penalty of up to $25 per day for each day that Form 3921 is late, up to a maximum of $15,000. The penalty will be reduced if you can show that the late filing was due to reasonable cause.
In addition to the penalty, the IRS may also assess interest on any taxes that are due as a result of the late filing of Form 3921. The interest rate is currently 6% per year.
To avoid the penalties for late filing of Form 3921, it is important to file the form on time. If you are unable to file the form on time, you should contact the IRS as soon as possible to request an extension.
Resources
- Understand the difference between ISOs and NSOs here.
- IRS- About Form 3921, Exercise of an Incentive Stock Option Under Section 422(b)
- Copy of Form 3921
- Instructions for Forms 3921 and 3922
- Learn everything you need to know about accounting for your startup here.
- Dive into valuable business startup resources here.
Visible Can Help Your Startup Stay In-the-Know
Understanding and managing the intricacies of Form 3921 can be overwhelming, but Visible is happy to help navigate this and more! Leveraging tools and platforms, like Visible, can streamline processes, and let startups focus on what they do best: innovating and growing.
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