Employee Options for ESPP & ISO(Form 3921, 3922, 6251)

Company choose a stock option program like the ESPP or ISO to offer their employees a chance to own the company shares.

Have you ever wondered why other companies tend to get the best talents easily with the same salary offerings but your company isn’t able to retain any good talent in your company? Well, there are a lot of businesses that offer their employees with more than just a salary and with the trend of offering stock options growing, it is common for employers to offer their employees with stock option plans like ESPPs and the ISOs. But what does this do to keep the employees in one company for a long time?

The answer is simple – as soon as an employee purchases or is awarded with shares from the company’s stocks, the employee begins to work for the company as though it is their own. And why wouldn’t they? The value of the company and the shares would increase only if the company grows and the company would grow only if the employees give their best. With the willingness to bring out the best of the company and earn a huge buck from it (due to the awarded shares too), employees begin to love their workplace and offer more productivity as well.

Company choose a stock option program like the ESPP or ISO to offer their employees a chance to own the company shares. Once the program is set, the process begins where the employee contributes from their paycheck to the company for a period. The employees can then sell these shares later on for a gain and enjoy the benefits from their hard work. However, they must also file these gains for tax purposes to the IRS.

For this, there are various forms that are used out of which, this article would talk about the Form 3921, 3922 and 6251. You would also understand all the details on how to file the form 3921, how to file the form 3922, and also how to file the form 6251.

Summary of Employee options for ESPP & ISO

Before we can talk about the instructions on how to file the form 3921, or the form 3922 for the employee compensation, let us understand what the ESPP and ISOs are all about briefly.

What Is an Employee Stock Purchase Plan?

The ESPP, known as employee stock purchase plan, is a program that is run by the company that employees can purchase the shares of the company at a set price. Before we learn how to file Form 3921, let us dig deeper into understanding ESPPs, as they are the ones that are reported in these forms. There are two groups of employee stock purchase plans and they are:

  • Qualified Employee Stock Purchase Plan – This is the most common plan where participants have equal rights. This plan has to be approved by the shareholders, where the period of the plan does not exceed 3 years or 27 months. Also, there are limitations on the highest price discount which might usually go above 15%.
  • Nonqualified Employee Stock Purchase Plan – In this plan, there are no rules like the qualified plan. For instance, there aren’t any after-tax deductions in this plan and the tax advantages are different in this plan.

Some Key Dates and Definitions

  • Purchase Period – This is the day when the employees purchase the shares and the payroll deductions begin.
  • Offering Period – The time period when the employee is allowed to take part in the ESPP. It takes place as the same time as the grant date for the stock options plan grant date. It has two kinds of offering period:
  • Consecutive Period – The time when there is a purchase date after the multiple purchase dates have passed.
  • Overlapping Period – The time when the shares have different prices due to multiple purchase dates.

Who Is Eligible to Take Part in an ESPP?

  • Those people who already have about 5% of the stock of the company are not able to take part in this program.
  • The people who are employed in the company for a particular time period (which is normally at least a year), have the choice to participate but are not obligated to do so.

As soon as an employee chooses to participate, they have to also choose how much they are going to contribute towards the plan. The employee can contribute up to $25,000 annually as per IRS standards, unless the employer has place a limitation on this amount.

A lot of ESPPs are offered at a discount on the share price of about 15% from the market value at the time of the grant. And it is due to this discount that employers enjoy a gain when the shares are sold later on. The employers have the choice to alter the levels in which the contributions take place or add their own policies about the withdrawal of funds in the ESPP between the purchase dates.

What Determines a Tax Treatment?

To know how to file Form 3921, or how to file Form 3922, we need to understand the tax treatment of ESPP. The tax treatment on the ESPP the moment they are sold are as follows:

  • The closing price of the stock on the purchase date.
  • The closing price of the stock on the offering date.
  • The price for which the stock is sold, considering all the discounts as well.
  • The time period for which the stock was held.

The ESPP stock that is qualified and held for at least two years from the offering date and one year from the purchase date would get a positive tax treatment.

Dispositions of Tax Treatments

Under the ESPP, two kinds of dispositions exist when it comes to the tax treatments as shared below:

  • A Disqualifying Disposition – In this, a considerable amount greater of the sale proceeds is counted as ordinary income. The difference between the closing price of the final stock on the purchase date and the discounted purchase price that is taken as ordinary income is factored.
  • A Qualifying Disposition – If the criteria for qualifying dispositions is met, the employees would experience two types of taxable income or losses on which the sale took place.
  • Long term capital gain – This is the left amount after the discount is used.
  • Ordinary income – This is the amount of the discount that is offered in the ESPP. For example, it can be 15%.

ISO – Incentive Stock Options

Just like we needed to know all about the ESPPs regarding how to file Form 3921 and how to file Form 3922, we also need to learn all about ISOs. Incentive Stock Options offer the employees options to own shares and also enjoy many favorable tax treatments as compared to the non-qualified stock options.

If a person exercises the non-qualified stock option, they would need to pay the ordinary income taxes on the excess of the FMV of the shares on exercise over the exercise price (which is called the spread). Nonetheless, ISOs aren’t subject to any ordinary income tax in case they are held for both of the following:

  • two years from the grant date; and
  • one year from the exercise date.

There is no income tax placed during the grant or the exercising of the ISO for the employee. However, the spread is used for adjusting the taxes to calculate the alternative minimum tax. If there is any profit that was made on the sale of the shares, it would be taxed as long-term capital gains.

From the perspective of the employer, ISOs are not as attractive as non-qualified stock options, as the employer does not get any tax deduction when the employee exercises the ISO.

For an option to be qualified as an ISO:

  • The rules placed on the option should not claim that the option should not be taken as an ISO.
  • An individual can get the option only if they are employed in the company offering the options or by a related company as per the Treasury Regulation Section 1.421-1(i)(2).
  • The option should be available in the purchase stock of the related company employer or the main employer.
  • There has to be a formal plan for granting the option after the approval of the company’s shareholders. The grant should begin within 12 months of the approval and the plan set up by the company.
  • The ISO plan should include:
  • The class of employees or employees that are eligible to obtain the options or any other awards under the plan. In case there are eligible non-employees to be part of the plan, it is important to separately designate the class of employees that are eligible to get the ISOs; and
  • the maximum total number of shares that can be issued as soon as the ISOs are exercised.
  • It is vital that the option has to be granted within a 10-year period from the earlier of:
  • the date on when the plan was approved by company’s shareholders; or
  • the date on when the plan was adopted.
  • The terms of the option has to state that it cannot be exercised after 10 years from the grant date, or five years after it is granted to an employee who already has shared that accounts for 10% or more of the complete voting power of all the stock classes in the company, its subsidiary or its parent.
  • The option’s exercise price cannot be less than:
  • 110% of the FMV of the shares on the date of grant for employees that are the 10% shareholders of the company; or
  • the FMV of the shares on the date of the grant for those employees that aren’t the 10% shareholders of the company.
  • The terms of the option has to:
  • State that the option can be exercised only by the company’s employee within the lifetime of the employee; and
  • Forbid the passing of an option by the company’s employee other than by the law of the distribution and descent or by will.
  • For all the employees, the overall FMV of the ISOs that are exercisable for the very first time in a year can’t exceed $100,000 (the FMV is figured out on the grant date).
  • The person who holds the option has to be an employee or related to the company that is offering the option at all the time from the starting of the granting period to the day three months before the exercising date.
  • If the employee’s employment in the company is terminated due to the death of the employee, the heir of the person can exercise the option until the expiration date of the option.
  • If the employee’s employment in the company is terminated due to the total and permanent disability of the employee, the employee would have to exercise the option no later than one year after the date of termination of the employee.

Provisions that Do Not Disqualify an Incentive Stock Option

When an option is qualified to be an ISO, it doesn’t fail to be an ISO since it has the below shared provisions:

  • The option grants a right or is subjected to a condition that is not conflicting the ISO rules to the person who has it.
  • The person holding the option has the rights to get extra compensation as soon as the option has been exercised. This is only in case the added compensation can be included in the income as per the Section 83 or Section 61 of the IRC (Internal Revenue Code).
  • The person who holds the option is allowed to pay the exercise price of the beforehand received shares of the company that awarded the ISO.

What are the Forms 3921, 3922, 6251?

These forms are used to file for the taxes on the ISO and ESPP, whichever applicable. Below are the details that let us know all about how to file the form 3921, how to file the form 6251, or how to file the form 3922. All has been explained below:

What is form 3921?

To begin with, the form 3921 is used by companies to report when a shareholder has just exercised the ISO to the IRS. It is a form that is important to file in the year in which the ISO has been exercised. As soon as the company fills the form, a copy has to be sent to the shareholder applicable and the form 3921 has to be sent to the IRS. It is important to print the form on the IRS-special printed paper.

What is form 3922?

Another form that is used for any equity compensation is the IRS Form 3922. This form is called the “Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c).” It is a form that is mainly used for informational purposes. This means that it is not entered into the tax return of an employee. In short, this is a form filled by the employer to the employee when a share has been transferred to the employee.

The information that is shared on the form 3922 would be used when the stocks are sold by the company to the employee. And this details would be needed when the employee wants to sell the stock further to someone else. This is the reason why it should be kept by the employee in the records for any detail that needs cross-checking. The moment the stocks are sold by an employee, the broker or Barter Exchange Transactions agency that helped in selling the stock would file the IRS form 1099-B and send the copy to the employee while the main copy goes to the IRS.

From the form 1099-B, the employee would report all about the sales in their tax return. And for figuring out some parts of the tax return, the form 3922 would come in handy. In short, the details shares on the form 3922 would help the employee find out the cost or any other basis that has to be added in the form as well as the holding period. Moreover, the exercise price here has to be less than 100% of the stock’s value on the date shown on the box 1 or if it was not fixed or determinable on the specific date.

When an option is exercised under the ESPP, no income is recognized at all. Nonetheless, it is important to recognize and report the capital gains or losses in the tax return during the year in which the stocks were sold or if they were just disposed of. With the help of the form 3922, it is easier to figure out the loss or gains. For any other details in how to file the form 3921, or how to file the form 3922, you can visit a lawyer, the IRS website or an IRS official.

What is form 6251?

For those income earners who are able to earn a specific amount of money, and are not able to remove all or most of the income from taxation using the credits and deductions, the IRS has imposed the AMT (Alternative Minimum Tax) on them.

Even though reducing the overall income that is taxable to 0 is legal, the IRS utilizes the AMT to make sure that each person pays their fair share of taxes to the government. And for calculating the AMT of a taxpayer, the form 6251 is used. In the next part, you would understand all about how to calculate the AMT and how to file the form 6251.

Purpose of these forms to IRS

The businesses in which the shareholders that have exercised their ISOs during the last year need to report about it to the IRS via the forms 3922 or the form 3921. It is crucial to fill and file these forms if:

  • In your company, there are are shareholders with Incentive Stock Options (ISOs), and
  • Any shareholder has exercised their ISOs.

Other than the forms 3922, and 3921, there is another form called the form 6251. As per the government, it is important for estates, trusts, corporations, and individuals that have AMT calculations exceeding their standard income tax liability calculations to pay the percentage of the difference amount.

This is not an alternative or additional part for regular income taxes. Instead, it is a different method to calculate the liability. In short, the form 6251 makes sure that those people who have multiple allowable deductions do not end up paying no tax or just a little tax.

Steps how to file these forms

Now that you are aware of the forms 3921, 3922, and 6251. Let us talk about the form 3921, and the steps we can take to file it.

In case you need to file the form 3921, you would have to prepare a statement for the person whose name is on the form. Before doing this, you would have to download the form 3921. To get the form online, you would have to visit the government agency’s website and download it, or visit the agency’s physical office to get the form.

Note (Same for all the IRS forms): As per the Treasury Regulations section 301.6109-4, every filer can truncate the employer identification number (EIN), adoption taxpayer identification number (ATIN), individual taxpayer identification number (ITIN), and recipient’s TIN (social security number (SSN) on payee statements. Even though this is allowed, it has to be noted that the truncation is not permitted on the documents that has to be filed with the IRS. Moreover, the TIN of the taxpayer cannot be truncated on any of the forms.

Below are the things that you would need to add in the form 3921 that would help you understand how to file the form 3921:

  • Employee’s Name, Address, and TIN: It is important to add the TIN, address, and name of the person who got the shares after the transfer due to the exercising of the option.
  • Account Number: In case there are several accounts for a person for whom the multiple 3921 form are being filed, the account number also had to be added here. In addition to this, the IRS encourages that an account number should be designated for all the form 3921 that are filed for the specific person.
  • Box 1: This is the field where the date on which the option was granted is added.
  • Box 2: This field is for the date on which the option was exercised.
  • Box 3: In this, it is important to add the exercise price per share.
  • Box 4: This field is for adding the FMV per share on the date when the option was exercised.
  • Box 5: Add the total number of shares that were transferred due to the exercising of the option.
  • Box 6: This field is to add the corporation’s TIN, address, and name whose shares are being transferred due to the options being exercised by an employee or so. These details have to be entered only in case the company isn’t the entity that is shown in the box named the TRANSFEROR which can be found on the upper-left of the form 3921.

As soon as the form is filled with the above shared instructions on how to fill the form 3921, it needs to be sent to the IRS office address via post or by handing it there personally.

Form 3922

Even though this form is a bit same as the form 3921, it has a few differences.. At first, you would need to get the form from the government agency or download it online and then fill it.

Below are the things that you would need to add in the form:

  • Employee’s Name, Address, and TIN: It is important to add the TIN, address, and name of the person who is transferring the shares.
  • Account Number: In case there are several accounts for a transferor for whom the multiple 3922 form are being filed, the account number also had to be added here. In addition to this, the IRS encourages that an account number should be designated for all the form 3922 that are filed for the specific person.
  • Box 1: This is the field where the date on which the option was granted is added.
  • Box 2: This field is for the date on which the option was exercised.
  • Box 3: This field is for adding the FMV per share on the date when the option was granted.
  • Box 4: This field is for adding the FMV per share on the date when the option was exercised.
  • Box 5: In this box, the price per share has to be added on the date when the option was exercised.
  • Box 6: This holds the total number of shares that have been transferred and to which legal title has it been transferred to.
  • Box 7: This box would hold the date on which the legal title of the shares were initially transferred.
  • Box 8: In case the exercise price per share wasn’t determinable or fixed during the grant date as mentioned in the box 1, the exercise price per share has to be entered as determined as if the option was exercised during the grant date entered in the box 1. In case the exercise price per share is determinable or fixed on the grant date entered in box 1, then this box 8 should be left blank.

Form 6251

It is important as per the IRS for each taxpayer to find out if they are subjected to the AMT in every tax year. Nonetheless, there are many cases where the income amount that has been earned in a year by the taxpayer might not even approve a separate estimate based on the income level. The form 6251 is used to find out the AMT value and report it. Below are the instructions on how to file the form 6251.

In case you owe AMT, this means that it is important to calculate the value. It should be kept in mind that this calculation is not the same as the one done on the income tax return form 1040. The AMT form would help to get the alternative minimum taxable income that would reduce a few of the tax benefits that has been claimed on the form 1040 so that the overall tax bill that needs to be paid increases.

In the starting of the form 6251, you would find the Adjusted Gross Income (AGI) in case the deductions are not itemized; or it would use the taxable income with the dependent and personal exemptions added back. To get the AMT income, the form would either remove or reduce the losses or deductions that you initially claimed like the investment interest expense, net operating losses, or even the medical and dental deduction.

As soon as you have finished filling the form 6251, you would need to add it to the personal income tax return. Nonetheless, you would also have to add the AMT amount you have to pay on the form 1040 on a special box made for it.

Conclusion

Now that you know how to file the form 3921, 3922 & 6251 and all about the forms, you are ready to offer the ISOs or ESPPs to your employees to allow them gain the tax benefits it has. This would also let them enjoy working with you as they would consider your business growth as their growth as well. If you want to offer the other type of stock options, check out the next post to learn all about the tax effects on them and how to file the respective forms!

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