If your company has had employees exercise incentive stock options (“ISOs”), you are required to report certain information to the IRS and the optionee about the exercise.
ISO Tax Reporting
There is no income or employment tax withholding required on the exercise of an ISO. But there is an annual tax reporting obligation to the IRS and the employee.
You have to provide the employee with Form 3921 by January 31st of the year following the year of exercise.
You have to file the Form 3921 with the IRS by February 28 of the year following the year of exercise of the ISO (unless you file electronically in which case the due date is March 31 of the year following the year of exercise).
Here is what Form 3921 looks like:
Where to Find the IRS’s Instructions and the Form Itself
Here is the IRS’s web site on this issue.
The Information Required to be Reported
The form requires you to give the IRS and each employee exercising an ISO the following key information:
- The date of the option grant;
- The date of option exercise;
- The exercise price per share;
- The fair market value per share on the date the option was exercised;
- The number of shares exercised; and
- The name, address, and employer identification number (EIN) of the corporation whose stock is being transferred pursuant to the exercise of the option, if the corporation is not the entity shown in the TRANSFEROR boxes in the upper left corner of Form 3921.
The employee will need this information to calculate what taxes they might owe on the ISO exercise. Again, there is no ordinary income tax due on the exercise of an ISO, but the spread on exercise is an AMT adjustment. The AMT liability on the exercise of an ISO can be significant. In fact, during the dot com boom/bust many employees exercised ISOs and owed more in AMT than the stock was worth when they finally figured out their tax obligations.
There was so much political fallout from this that Congress actually passed a one time exemption for people who still hadn’t paid their AMT taxes years later (but didn’t provide a refund for people who had).
What is the lesson from all of this? Be aware of the potential magnitude of the AMT when exercising ISOs.