Incentive Stock Options (ISOs) allow employees to buy company stock at a low price and profit from company success, incentivizing them as true stakeholders.
ISOs offer the potential for tax-advantaged growth. That's a good thing, but it does increase your paperwork during tax season.
And look, tax filing is a pain for any company, especially startups. If your company offers stock options, you need to know about Form 3921.
What Is Form 3921? Do Startups Need to File It?
Form 3921 is used to report the grant of incentive stock options (ISOs) to an employee. If your startup grants ISOs to employees and they exercise their vested shares, you need to file Form 3921.
IRS Form 3921 is intended to keep a record of individuals or entities who received ISO compensation. The form calculates the amount of taxes the employee would owe if they sold their shares. The employee is taxed on the delta between the exercise price and the fair market value of the shares at the time of exercise.
Form 3921 helps the IRS identify the shareholders who received ISO compensation and later determines the gain or loss when these stocks are sold.
Each ISO exercise should be filed independently, so if you have a hundred employees who've exercised their vested shares, you'll need to file a hundred 3921 forms.
When Should You File Form 3921?
You can either file Form 3921 online or by mail.
Form 3921 includes three copies:
- Copy A — file with the IRS
- Copy B — for the employee who exercised an ISO
- Copy C — for the company's record
If any employee in your company exercised an ISO, you'd need to provide Form 3921 (Copy B) to that employee by Jan 31st of the following year.
For example, if an employee exercised an ISO in 2022, you'll need to provide Form 3921 to that employee by Jan 31st, 2023.
File Form 3921 (Copy A) with the IRS by Feb 28th (for paper filing) or March 31st (for e-filing) of the following year.
If you choose to file by mail, request Form 3921(Copy A) directly from the IRS. However, Copy B and Copy C can be downloaded from the IRS website and provided to your employee.
Here are the deadlines for filing Form 3921 if your employee exercised ISOs in 2022.
How to File Form 3921?
To fill out Form 3921, you need following information:
- Company’s Name
- Company’s Address
- Company’s TIN (Tax ID Number)
- Employee’s Name
- Employee’s Address
- Employee’s SSN
- Date Option Granted
- Date Option Exercised
- Exercise Price per Share
- Fair Market Value (FMV) per Share on Exercise Date
- Number of Shares Transferred
You can file Form 3921 online or through Carta. However, if you are filing for the first time, you'll need a TCC (Transmitter Control Code). The TCC is a unique code assigned to your company, used as an ID when filing returns electronically.
You get a TCC by filing Form 4419.
To generate your TCC, create a FIRE account on the IRS' Filing Information Returns Electronically (FIRE) system. Then, submit Form 4419. That'll generate your TCC.
The TCC processing time can take 45 days or longer, so apply before Nov 1st to meet your Form 3921 deadlines.
If you're using Carta, once you submit your TCC and the required information, it will automatically complete your Form 3921 and file it. Once you provide the employee's email addresses, Carta automatically distributes Copy B of Form 3921 to the employees who exercised their ISO.
You can also file on Track1099, which is time-saving and convenient if you have fewer than a hundred 3921s to file. You'll need to copy and paste information from all your 3921s on Track1099, and you can complete the filing process the same day.
Are There Any Penalties for Incomplete or Late Filing?
Yes, a penalty fee may be imposed if you delay filing Form 3921 or file an incomplete or incorrect form. This ultimately depends on when you actually do submit Form 3921.
If you intentionally delayed the filing, IRS can impose a maximum fine of $570 for each delayed form. That's unpleasantly expensive, so don't forget about that 45-day lead time on acquiring a TCC.
Here's a list of the penalty fees you'll have to pay if you delay filing:
So, capped at just a bit over three million bucks for startups. What a relief.
Get your 3921s in on time.
Is Exercising ISOs Taxable?
ISOs are only available to employees and can only be used to buy company stock. Exercising ISOs is not considered income tax and is exempt from FICA taxes.
However, there are certain taxes associated with ISOs. For example, when the stock is sold, the employee must pay capital gains tax on the difference between the exercise and sale prices. But, if the shares are held long enough, the entire sale may be taxed at the long-term capital gains rate, which is lower than the ordinary income tax rate.
In addition, an employee is responsible for income tax when they exercise their NSOs (Non-qualified Stock Options) as well as capital gains taxes when they sell their NSO shares (this doesn't apply if you're selling right away).
