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Equity compensation is a well-regarded strategy used by startups to reward key employees by offering them an equity stake. This can be achieved through various stock-based compensation methods, including Employee Stock Purchase Plans (ESPPs), Employee Stock Ownership Plans (ESOPs), and Restricted Stock Awards (RSAs).
Out of these, ESPP is a popular benefit program that enables your employees to acquire company stock at a lower price via payroll deductions. However, for seamless stock option grants through this method, you need to consider several important factors, including Form 3922. It is an integral part of the Internal Revenue Code (IRC) and plays a significant role in the process of granting stock options.
This blog covers the different aspects of Form 3922, including its importance, filing process, important dates, penalties, and record-keeping requirements.
Form 3922 is widely known as the 'Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c)'. It is an important tax document to intimate the Internal Revenue Service (IRS) regarding the transfer of stock obtained through an ESPP.
This form captures key details about the stock purchase, such as the exercise price, the stock's Fair Market Value (FMV) on the purchase date, and the date on which the employee acquired the shares.
Form 3922 is primarily used for informational purposes only. It is not directly reported on the employee's tax return unless they sell the acquired stock. However, the information provided on Form 3922 is essential for employees to accurately report their stock-related tax liabilities when they sell the shares.
For example, let's consider an employee, Maria, who purchased 100 shares of your startup's stock at a discounted price of $20 per share through an ESPP. The FMV on the purchase date was $25 per share. As Maria acquired the shares at a price lower than FMV, this transaction triggered the need for Form 3922.
If Maria sells the shares at a price higher than the exercise price, she will have a capital gain. Alternatively, on selling the shares at a price lower than the exercise price, she will have a capital loss. Form 3922 features the necessary information to calculate these gains or losses, therefore helping Maria accurately report her stock-related tax liabilities.
ESPPs provide employees an opportunity to invest in the company's stock and potentially benefit from any future appreciation in value. ESPPs have been created to foster employee ownership and align their interests with the enterprise's performance. Employees can acquire these plans at a discounted price directly from their payroll, making the entire process a seamless experience.
Participating in an ESPP can have significant tax implications for employees. One key aspect is the 'bargain element,' which represents the difference between the FMV of the stock on the purchase date and the actual purchase price. Form 3922 plays a crucial role in this process. It provides the necessary information to calculate the bargain element and any capital gains or losses from the sale of the shares.
The bargain element is considered ordinary income and is subject to income tax withholding. Additionally, when employees sell the acquired stock, they might need to pay capital gains taxes on any appreciation in value since the purchase date. The holding period of the stock, whether short-term (held for one year or less) or long-term (held for more than one year), can impact the tax treatment of any gains realized from the sale.
The IRS taxes short-term capital gains at higher rates than long-term gains, so understanding the holding period of the stock acquired through an ESPP is essential for employees to plan their tax strategies effectively.
When it comes to tax forms related to stock transactions, it is important to distinguish between Form 3922 and Form 3921. These forms are often confused due to their similar names and purposes, but they serve distinct functions and have unique reporting requirements.
Form 3921 is specifically designed to report transactions related to Incentive Stock Options (ISOs). ISOs are stock options granted to employees with the aim of providing them with a stake in the company. When an employee exercises ISOs, the company is required to report this transaction on Form 3921. This form helps the IRS determine the appropriate taxes due to the employees' exercise of ISOs.
On the other hand, Form 3922 is meant to inform the IRS about the first transfer of legal title of stock acquired through ESPP. Form 3922 provides details like the date of transfer, FMV of the stock, and the exercise price per share.
The key distinction between Form 3921 and Form 3922 lies in the type of stock transactions they report. Form 3921 focuses on ISOs, while Form 3922 pertains to ESPPs.
Form 3922 serves as a crucial tool in the financial ecosystem of startups. Here’s why:
When employees purchase company stock at a discounted price through an ESPP, as an employer, you must report this transaction by issuing Form 3922. You have to submit the form to the IRS and provide a copy of the form to the employee who made the purchase. This dual filing ensures that both the IRS and the employee have accurate records of the transaction.
Employees who receive company stock through an ESPP are also required to keep a copy of Form 3922 for their tax records. Employees need not include the information in this form on their tax returns if they do not sell any of the acquired company stocks. However, having this form is crucial for maintaining accurate records of stock transactions and potential tax implications.
Here is a step-by-step guide to help you complete and submit Form 3922 efficiently:
Step 1: Gather Required Information
Collect essential details related to the stock transfer. This includes the employee's name, Social Security Number (SSN), stock transfer date, FMV of the stock on the transfer date, and the exercise price per share.
Step 2: Complete Form 3922
Fill out Form 3922 with the gathered information. Ensure accuracy and double-check all entries to avoid errors. Any discrepancy can lead to potential tax issues with the IRS.
Step 3: Distribute Form 3922 to Employees
Provide Copy B of Form 3922 to the employee who acquired company stock through the ESPP. Employees need this form for their tax records.
Step 4: Submit Form 3922 to the IRS
File Copy A of Form 3922 along with Form 1096 (Annual Summary and Transmittal of US Information Returns) with the IRS by February 28, 2024, or April 1, 2024, if filed electronically. Ensure timely submission to comply with tax regulations. You can submit Form 3922 electronically through the IRS's Filing Information Returns Electronically (FIRE) system or by mailing it to the specified address.
An exemption can be obtained from the IRS when the original transfer of stock ownership is completed by either:
This exemption is limited to any tax year within the period starting from when the stock option was granted to them and ending when they first acquired ownership of the ESPP shares.
Form 3922 includes several data fields that provide essential information for accurate tax reporting. These fields include:
Meeting the deadlines for IRS Form 3922 is crucial to avoid potential penalties from the IRS. Here is a breakdown of the key dates to remember:
You can also request an extension in the deadline for providing Copy B of Form 3922 to current or previous employees.
If these dates happen to fall on a holiday, the due dates will be the next day. Missing these deadlines can result in penalties from the IRS. Make sure to factor them into your ESPP administration process to ensure timely compliance.
Once you have submitted Form 3922s, you must store them safely for easy access during tax return filings. Here are some best practices to help you with the process:
Failing to file Form 3922 or inaccurately submitting it can lead to significant penalties for employers. The IRS imposes fines based on the delay and the accuracy of the information provided. The penalty amount differs for small businesses whose taxable income for the last three years is below an average of $5 million.
If it is established that you have deliberately failed to submit the return or have furnished incorrect information, then the penalty is $630 per statement. There is no capping on the maximum penalty in this case.
This penalty applies separately to the copies to be submitted to the IRS and to be provided to the employee or ex-employee. If you are unable to provide copies of both, the penalties mentioned above and the maximum capping are both doubled.
Form 3922 plays a pivotal role in the accurate filing of taxes for both employers and employees involved in ESPPs. However, any errors in this form can result in potentially significant penalties and fines from the IRS. Hence, you need to get professional guidance to avoid any such unwanted outcomes.
This is where Qapita, a leading equity management platform, comes into the picture. Rated as the best Equity Management Software by G2, we simplify the management of ownership in companies.
Currently, Qapita supports over 2,200+ fast-growing companies with solutions for equity management, cap table management, and ESPP administration, which help with IRS compliances.
Connect with the experts at Qapita today and learn more about the available services that can streamline your stock option practices.
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