Receiving stock options can be an exciting part of your career. You have a vested interest in the success of your business, and if things go well, you can potentially make a lot of money if the stock goes up. Incentive Stock Options (ISOs) can significantly impact your taxes at the end of the year. Understanding the implications of the lucrative options is important for avoiding surprises at tax time. But how do you report these stock options to the IRS? The answer is Form 3921.
What is Form 3921?
Form 3921 is a tax form that provides employees with information about ISOs that are exercising.
Companies must file this form with the IRS and provide a copy to the employee. The form consists of several sections, each capturing specific details about the stock option transaction:
- Exercise Price Per Share: The price at which the employee can purchase the stock.
- Fair Market Value Per Share on Exercise Date: The stock’s value on the date somebody exercised the option.
- Number of Shares Transferred: The total number of shares the employee purchased.
- Date Option Granted: When the company provided the ISO to the employee.
- Date Option Exercised: When the employee exercised the ISO.
You can view a blank Form 3921 at IRS.gov.
If you exercise multiple lots of options, you may receive several of these forms from your company. Keep track of your exercised options throughout the years and compare them to the forms you receive from your company. You should contact them immediately if there is a discrepancy.
Key Dates to Remember with Form 3921
The deadline for companies to provide Form 3921 to employees is January 31 of the year after the ISO was exercising. You should receive the form from your company shortly after the January 31 filing deadline.
Additionally, it is crucial to understand the timing of exercising and selling ISOs, as it can significantly impact the tax benefits. If you exercise shares and still hold them at the end of the year, the implications are different than if you have sold them during the year. December 31 is a crucial cutoff date if you’re holding these shares.
How to Read Form 3921
Each box on Form 3921 provides essential information:
- Box 1: Shows the date the ISO was granted.
- Box 2: Indicates the date the ISO was exercising.
- Box 3: Displays the exercise price per share.
- Box 4: Provides the fair market value per share on the exercise date.
- Box 5: Lists the number of shares transferred.
All the information on Form 3921 is important and will impact your tax liability.
Does It Impact Tax Liability?
Exercising ISOs can have tax implications.
If you sell the stock immediately after exercising, the IRS treats it as regular income. Note that exercising the stock immediately will create short-term capital gains, which tax at your regular income tax rate.
However, if you hold onto the stock for a year or longer, any profit made from selling the stock is taxed at the long-term capital gains rate, which is typically lower.
If you exercise ISOs and still hold the stock at the end of the year, the difference between the exercise price and fair market value on the exercise times the number of shares exercised will be an Alternative Minimum Tax (AMT) adjustment. The AMT adjustment can have significant tax implications depending on how big the adjustment is.
It’s important to understand that exercising the ISOs can lead to AMT even if you do not sell the stock.
When you exercise ISOs, your company allows you to sell part of the award to pay for withholding, but this is not required, so it’s possible that exercising your ISOs has created income without any withholding.
Along with federal taxes, you must consider state tax implications when exercising ISOs. Many states also have their own form for AMT and consider ISOs when calculating their state AMT.
Common Mistakes and Red Flags
When filing a Form 3921, the most common mistake is incorrect information. You should immediately review the form for accuracy if you receive a 3921 from your company.
Not making an AMT adjustment for exercised stock options that you hold at the end of the year can trigger an audit by the IRS. Remember that you file Form 3921 with the IRS. They can compare the form filed against your tax return to look for discrepancies.
Do I Need a Tax Pro?
While some individuals are comfortable navigating ISOs and Form 3921 independently, many situations warrant professional advice. If your ISO transactions are complex or you are unsure about the tax implications, consulting a tax professional, especially one specializing in stock options, is advisable.
Suppose you’ve exercised a significant number of ISOs. You should consult a tax professional early in the year to determine the tax implications. The income created by exercised stock options may put you in a situation where you must make estimated tax payments throughout the year. A tax professional can help you with these calculations and ensure that you avoid penalties and interest for underpayment of taxes.
You should also consider any periods where you are not allowed to sell your stock. If your company enters a dark period, you may not be allowed to liquidate your stock to pay the taxes due. A tax professional can help you proactively prepare for this possibility by determining your potential tax liability and ways to minimize the tax implications of your ISOs.
Incentive Stock Options offer a unique opportunity for employees to participate in the company’s growth. However, the associated tax implications can be complex. This is particularly true around Form 3921. Many people have been unaware of the impact of exercising ISOs and selling the stock or continuing to hold it at the end of the year.
While understanding the basics is essential, consulting a tax professional like Tax Hack can provide tailored advice, ensuring you minimize your taxes while staying compliant with tax laws.