If a company grants incentive stock options to its employees, it needs to be familiar with IRS Form 3921. Form 3921 notice and filing obligations are triggered if any employees exercised incentive stock options (ISOs) during the prior calendar year. But before explaining what a company needs to do, let’s cover why the IRS cares.
Form 3921 requires the company to report to the IRS information about an ISO exercise, including the exercise date, the exercise price, the fair market value (FMV) of the stock as of the exercise date, and the number of shares acquired. The IRS cares if the FMV exceeded the exercise price because this difference, or “spread,” is included as income for alternative minimum tax (AMT) purposes. Now I’m not going to bore you to death by trying to explain the AMT, suffice to say it makes certain people pay more tax than they otherwise would considering the deductions or exemptions they would normally claim. If the AMT applies to your employees and there is a spread when they exercise their ISOs, they may be stuck paying a higher amount of income tax. You may recall that one of the benefits of an ISO is that an exercise of an ISO is not a taxable event for regular income tax purposes. But it’s different under the AMT income tax calculation and the Form 3921 gives the IRS a way to confirm income that is to be included in the calculation of your employee’s AMT liability.
Let’s illustrate this with an example. Say that you exercised an ISO to acquire 100 shares of stock in 2017. The exercise price was $10 per share and the shares had already vested in the time that had elapsed since the grant (i.e., were no longer subject to forfeiture). You held those 100 shares through the end of 2017 and the company sent you a Form 3921 in early 2018 that listed the fair market value of its stock as of the exercise date at $25 per share. There is a difference of $15 per share, or $1500 (($25 - $10) x 100) = $1500) between what you paid for the shares and what they were worth when you bought them, and you need to include that $1500 difference as income for purposes of your AMT calculation. This is the case even if the value of the shares subsequently falls below $25. The key for calculating your AMT income is whether the fair market value on the day you exercised your ISOs exceeded the exercise price. Now if the Form 3921 identified the fair market value of the shares as $10 on the day you exercised, you would not have any amount to add to your AMT income in connection with this exercise of ISOs.
What does the company need to do if a Form 3921 obligation is triggered?
If ISOs were exercised, the company has a Form 3921 obligation. The company needs to do two things: (a) provide a Form 3921 to the employees that exercised an ISO and do this by January 31st of the following year, and (b) file a Form 3921 for each exercise with the IRS by February 28th (if filing by paper and you used the scannable IRS form) or March 31st (if filing electronically) of the following year. Save some headache and fulfill these obligations electronically (Shoobx can help).
The FMV listed on the Form 3921 wasn’t what I expected. What can I do?
It is the company who determines the FMV that gets reported on the Form 3921, and the company is required to follow Section 409A regulations in doing so. This means that the reported FMV has already gone through a lot of hoops/approvals and is a firm value. But if you have questions about the FMV reported on your Form 3921, you should speak to the company.
Are there any filing exceptions?
A Form 3921 isn’t required for an ISO exercised by a nonresident alien where the corporation isn’t required to provide a Form W-2 to that person. This exception most likely applies to companies that are granting ISOs for the stock of a U.S.-based parent company to employees of a foreign subsidiary.
What happens if the company forgets its Form 3921 filing obligations?
The IRS will impose penalties if the company missed the deadlines or forgot about them altogether. These range from $50 per form if the company files within 30 days of the deadline to $250 if the company never even filed (these amounts were last changed in 2015 and could be changed again in the future). Be also warned that the IRS will impose additional penalties if the company never sent employees a Form 3921 or if any of the company’s failures to file were intentional, i.e., it knew about the obligation but decided to ignore it. This also suggests that if the company discovers that it forgot about filing your Form 3921, that failure should be fixed quickly.
It's important for a company to keep track of option exercises for many reasons -- one of those reasons is that it needs to comply with Form 3921 obligations. Do your company a favor and find a service provider that already stores the necessary information relating to ISO exercises and can leverage it for you as your company navigates the requirements of Form 3921.