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Reminder: January 31, 2011 Reporting Requirements for ISO Exercises and ESPP Purchases During 2010

January 10, 2011

Companies that grant incentive stock options qualified under Section 422 of the Internal Revenue Code (ISOs) or maintain employee stock purchase plans qualified under Section 423 of the Internal Revenue Code (ESPPs) are subject to new reporting requirements under Section 6039 of the Internal Revenue Code. The IRS’s final regulations under Section 6039 require companies to provide detailed information on ISO exercises and ESPP purchases to both the IRS and the employee involved in the transaction. The information on transactions that occurred during 2010 must be provided to employees by January 31, 2011 and filed with the IRS by February 28, 2011 (or by March 31, 2011 if filing electronically).

Background. Whenever employees acquire shares on exercise of an ISO, the company is required under Section 6039 to provide a written statement to the employee. In addition, companies are required to provide a written statement whenever employees who have purchased shares under an ESPP at a price less than the fair market value of the shares as of the grant date (i.e. the first day of the ESPP offering period) subsequently sell or otherwise dispose of those shares. In each case, the statement generally must include the address and taxpayer identification numbers for both the company and the employee and detail about the exercise of the option. The purpose of the statement is to provide employees with information to calculate their tax liability that may apply on exercise of an ISO (e.g. liability for the alternative minimum tax) and on the sale or transfer of stock purchased under an ESPP.

New Reporting Requirements. Prior to 2010, the company was only required to furnish information about the transaction to the employee. However, for exercises of ISOs and transfers of ESPP shares that occur after 2009, the Section 6039 regulations require that the following information be filed with the IRS and provided to the employee:

With respect to the exercise of an ISO, the company must provide:

  • The name, address and employer identification number of the corporation transferring the stock (and, if different, the name and address of the corporation issuing the stock).
  • The name, address and taxpayer identification number of the person exercising the option.
  • The date the option was granted.
  • The exercise price of the option.
  • The date the option was exercised.
  • The fair market value of the shares at the time of exercise.
  • The number of shares transferred on exercise of the option.

With respect to a subsequent sale or transfer by the employee of shares pursuant to an ESPP where the shares were purchased at a discount, the company must provide:

  • The name, address and employer identification number of the corporation issuing the shares.
  • The employee’s name, address and taxpayer identification number.
  • The date the option was granted.
  • The fair market value of the shares on the date of grant.
  • The exercise price paid for the shares.
  • The exercise price determined as if the option were exercised on the date the option was granted (to be provided only if the exercise price is not fixed or determinable on the grant date).
  • The date the option was exercised.
  • The fair market value of the shares at the time of exercise.
  • The date the shares were transferred by the employee.
  • The number of shares transferred by the employee.

The company will be required to provide this information on a return filed with the IRS and in a written statement provided to the employee. Based on IRS guidance, the written statement must be furnished to the employee by January 31, 2011, and the return must be filed with the IRS by February 28, 2011 (or by March 31, 2011 if filing electronically). The IRS guidance also provides that the statement may be furnished electronically to employees if the employee consents and certain other requirements are met. The IRS has issued Forms 3921 and 3922 for use in providing the information required under Section 6039 to the IRS and employees.

Special Rule for ESPP Transfers to Brokerage Account. As noted above, the reporting requirement for ESPP shares is triggered by the employee’s transfer of legal title to the shares. (This is different from the rule for ISOs where the reporting requirement is triggered by exercise of the ISO.) The regulations provide that the employee’s transfer of shares acquired on exercise of an ESPP option to a recognized broker or financial institution is treated as a transfer of the shares for purposes of Section 6039. Accordingly, if a company operates an ESPP pursuant to which shares acquired on exercise of an ESPP option will be immediately deposited to a brokerage account established for the employee, then the deposit of the shares into the brokerage account will trigger the reporting requirement.

This rule should help ESPP administrators to comply with the Section 6039 requirements as the date of exercise of the ESPP option and the date of the transfer that triggers the reporting requirement will generally be the same. By contrast, if a company issues shares acquired on exercise of an ESPP option to the employee in certificate or book-entry form, the reporting requirement will not triggered until the employee subsequently transfers the shares (e.g., by selling the shares or transferring them to a brokerage account). The company would be required to track the shares that have been issued to the employee and provide the information required under Section 6039 to the IRS and the employee only when the shares have subsequently been transferred by the employee.

Exemption for Shares Issued to Nonresident Aliens. The regulations also provide an exception to the reporting requirements for ISO exercises and transfers of ESPP shares by certain nonresident aliens. With respect to ISOs, the reporting requirements do not apply to an employee who is a nonresident alien and to whom the company is not required to provide a Form W-2 for the period beginning with January 1 of the calendar year in which the ISO is granted and ending with December 31 of the calendar year in which the ISO is exercised. With respect to ESPP shares, the reporting requirements do not apply to an employee who is a nonresident alien and to whom the company is not required to provide a Form W-2 for the period beginning with January 1 of the calender year in which the option is granted and ending with December 31 of the calendar year in which the transfer that triggers the reporting requirement occurs.