Section 403 of the Tax Relief and Health Care Act of 2006 (TRHCA) revised Section 6039 of the Internal Revenue Code (Code), which requires employers to file a return with the IRS, in addition to providing employees with an information statement, following a stock transfer pursuant to the exercise of an incentive stock option or the transfer of stock under an employee stock purchase plan (ESPP) if the stock was acquired pursuant to the exercise of an option described in Code Section 423(c) (special rule for ESPPs when option price is between 85% and 100% of fair market value of stock on the grant date). The intent behind these reporting and information statement requirements is to provide sufficient information to enable an employee to calculate his or her tax obligations upon the disposition of the shares acquired from the exercise of an incentive stock option or upon the exercise of an ESPP option described in Code Section 423(c).
Although the final regulations apply as of January 1, 2007, employers are not required to comply with the reporting requirement for stock transfers that occur during the 2007, 2008 and 2009 calendar years. However, the requirement to furnish information statements to employees does apply for the 2007, 2008 (with reliance on the 2004 regulations or 2008 proposed regulations) and 2009 calendar years (with reliance on the 2004 regulations, 2008 proposed regulations or 2009 final regulations).
Prior to the amendment in Section 403 of TRHCA, Code Section 6039 required employers to furnish a written statement to each employee, in a manner prescribed in the regulations under Code Section 6039, regarding (i) the employer’s transfer of stock pursuant to an employee’s exercise of an incentive stock option and (ii) the transfer of stock by the employee if the stock was acquired pursuant to the exercise of an option described in Section 423(c). Code Section 6039 requires that employers furnish information statements under this section on or before January 31 of the year following the year for which the statement is required. The IRS’s revisions to and clarifications of the July 2008 proposed regulations are summarized below.
Incentive Stock Option Reporting and Information Requirements
The final regulations did not revise the proposed regulations regarding the information required in the information statement delivered to the employee and the return filed with the IRS for transfers of shares pursuant to the exercise of an incentive stock option.
ESPP Reporting and Information Requirements
- Transfers of Stock under an ESPP
In light of comments the IRS received regarding the common practice of employers depositing employees’ shares acquired under an ESPP in a brokerage account, the final regulations modified the proposed regulations to provide that transfers of legal title to a recognized broker or financial institution immediately following the exercise of the option is treated as the first transfer of legal title for purposes of the filing of a return with the IRS.
If, instead of depositing the shares in a brokerage account, the employer issues a stock certificate to the employee, or the employer registers the shares in the employee’s name on the employer’s record books and the employer or its transfer agent holds the shares for the employee in book-entry form, then for purposes of the reporting and information statements, the issuance of the stock certificate or the registration in the employer’s records is not considered the first transfer of legal title of the stock acquired by the employee, and the employer’s obligation to file a return is not triggered. Instead, the obligation to file the return will arise when the employee first transfers the stock acquired by the employee (for example, when the employee sells the stock or transfers the stock to his or her brokerage account).
- Certain Options under an ESPP
If the exercise price for an option under an ESPP is not fixed or determinable on the grant date, the final regulations require the employer to include in the return and the information statement the grant date price as the exercise price per share.
- Triggering Event for Return and Information Statement for ESPPs
The final regulations clarify that the return and information statement requirements apply regardless of whether or not the shares issued under an ESPP pursuant to an option described in Code Section 423(c) are disposed of in a qualifying disposition. Additionally, the return and information statement are required if the exercise price for the option is not fixed or determinable on the grant date.
Return Requirements for Nonresident Aliens
The return requirement is not applicable to the exercise of an incentive stock option or an option described under Code Section 423(c) by an employee who is a nonresident alien and to whom the employer is not required to furnish a Form W-2 for any calendar year beginning with the year in which the option was granted and ending on the last day of the calendar year in which the incentive stock option or option described under Section 423(c) is exercised.
Forms Satisfying the Return and Information Statement Requirements
Form 3921, Exercise of an Incentive Stock Option under Section 422(b), has been designated to satisfy the return and information statement requirements for purposes of incentive stock options. For transfers of stock under an ESPP pursuant to an option described in Section 423(c), an employer can use Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c). Both forms 3921 and 3922 have yet to be released by the IRS but are expected soon. The IRS will permit taxpayers to satisfy the information statement by delivering a substitute form to the employee that includes all the information required on Forms 3921 or 3922, as applicable, in accordance with the guidelines of Publication 1179.