Startup companies often incentivize employees by offering stock options.
If these options adhere to a set of specific requirements, then these are known as Incentive Stock Options (ISOs). ISOs have significant tax benefits to employees and employers but also reporting requirements, such as form 3921.
First, find the right support
Before getting started, you’ll want to ensure you fully understand the 3921 form and decide how you plan on filing the form.
At Propeller, we provide fractional finance and accounting services to venture-stage companies, but we are not CPAs so we always recommend having a tax advisor for guidance on tax matters.
Doing the forms yourself may not be too tricky with the right online tool, but for specific tax-related questions, you’ll want to direct those to your tax professional. If you are working with Propeller, our team of accountants is knowledgeable about the online tools out there (such as Tax1099.com and Track1099.com) and are able to prepare, file, and share form 3921 on your behalf.
How do I make sure that I have all of the information I need?
Options (exercised or not) are captured in a well-maintained cap table, so as part of your year-end clean-up, make sure your cap table reflects all activity: all raises of cash, conversions of notes to equity, warrants, RSUs, and of course, stock options.
Propeller does not maintain cap tables on behalf of their clients, but a number of softwares, such as Carta, make it easy to self-manage.
Propeller’s knowledge of this software is a resource that many of our clients use when updating this software. But when in doubt, contact your attorney for advice!
What is Form 3921?
Form 3921 is a standard IRS form that must be completed and filed by a company for each tax year during which an employee exercises an ISO.
What is an ISO?
An ISO is an incentive stock option. It is an option to buy stock, subject to certain terms and conditions. These terms and conditions must be properly drafted in the contract offering the ISO, with one that stands out in particular: an ISO can only be offered to an employee of the company.
What is an NSO and how does it differ from an ISO?
An NSO (or NQSO or just “stock option”) is a non-qualified stock option. It is like an ISO, except that it does not adhere to the same terms and conditions that are required. As such, there are a few notable differences:
- An NSO is available to anyone, not just employees.
- An employee can only exercise ISOs up to a maximum value of $100k.
If an employee exercises stock options with a value in excess of $100k, this amount will be treated as an NSO.
- An NSO is NOT reported on a Form 3921 and does not carry many of the same tax benefits as an ISO. If there is any gain on exercise, this amount must be added to the person’s W-2 or on a 1099.
How could there be a gain on the exercise of an option?
If a person exercises a stock option at a price that is less than the fair market value of the stock, then the person has received something worth more than they paid for it. This difference is known as the “spread” and is considered a gain for tax purposes.
Think of it like this: an employee is offered to buy stock for $100, but the stock is worth $1,000. As such, by exercising the option, the employee has become enriched by $900 (the “spread” between the $100 and $1,000).
If the spread is from an NSO, then the full amount of gain becomes taxable and should be added to the employee’s W-2, or, if the person is not an employee, on 1099.
However, if the spread is from an ISO, it’s possible that not all of this will be taxable to the employee (though it may be taxable for high-income (AMT) earners).
When is Form 3921 Due?
Form 3921 is due to the IRS electronically by March 31 in the year following the close of the tax year. This is the most important deadline for businesses to know.
However, there are two additional deadlines to consider. If a business is not filing electronically and plans to file on pre-printed IRS forms, then these must be completed and postmarked by February 28.
Furthermore, businesses are required to provide employees with a copy of their 3921 by January 31 (effectively accelerating the deadline to complete the form).
If any of these deadline days falls on a weekend or legal holiday, then it is extended to be the next business day.
How Do I File Form 3921?
Many businesses elect to use approved third-party software, such as Tax1099.com or Track1099.com. These softwares allow a business to file a range of information filings, such as 3921s, 1099s, or even W-2s.
However, some businesses choose to register and file with the IRS directly. If filing online for the first time, you’ll need to file Form 4419 electronically. Once complete, you will be assigned a Transmitter Control Code, or TCC, by the IRS. After you get the TCC, you'll be able to set up an account on the Filing Information Returns Electronically system with the IRS. This is also known as the FIRE system.
When you file Form 3921 by mail, you can fill it out yourself and send it in the mail. However, it must be printed on special paper that is supplied by the IRS. You can order the paper that the IRS uses for Form 3921 on their website.
What do I need to complete the form 3921?
When completing the form itself, you'll need to provide the legal name of your business, primary address, and FEIN. You’ll also need the employee's name, address, and social security number. In addition, you'll need to provide the following information about the ISOs that were exercised:
- Date the option was granted
- Date the option was exercised
- The share price of the exercise
- The per-share fair market value on the date of the exercise
- The number of shares that were transferred
Failure to File Form 3921
Businesses may face significant financial penalties if they are late to file Form 3921 by the IRS due dates, and even greater penalties for failing to file at all.
Penalties for filing late are a minimum of $50 per form, ranging up to $290 for severely late forms or $580 for forms that are intentionally disregarded.
If all forms are filed within 30 days, the IRS caps the maximum penalty at $571,000 per year (or $199,500 for “small businesses”).
The most up-to-date penalty information can be found on the IRS website here: https://www.irs.gov/payments/information-return-penalties
Reach out to Propeller for more information on Form 3921 or any other of your accounting and finance needs.