IRS Form 3921: What is it and How to File?

As a founder, you must be aware of the different tax forms and reporting requirements linked to your startup's operations. One important document is Form 3921, which reports the exercise of Incentive Stock Options (ISOs) under Sec 422(b) of the Internal Revenue Code (IRC).

When your employees exercise an ISO, they purchase the company shares at a pre-determined price, known as the exercise price. Form 3921 documents this transaction, providing you and the IRS with the necessary information to accurately report the transaction on tax returns.

This blog covers the specifics of Form 3921, including its meaning, importance, types, filing process and associated compliances. 

What is Form 3921?

Form 3921 is an important tax document that provides details of the ISOs your employees exercise. It covers information like the option grant date and the day on which the option was exercised. It also provides data related to the Fair Market Value (FMV) per share on the exercise date, the exercise price per share and the number of shares acquired through the exercise.

As an employer, you must submit Form 3921 with the IRS for every ISO stock option exercise transaction. This is a mandatory requirement, irrespective of the number of shares involved. You also need to provide a copy of this form to every employee. If you do not comply with these guidelines, the IRS can levy penalties for every form not filed correctly.

Who should file Form 3921?

Any company that transfers stock to an employee under an ISO is responsible for filing Form 3921. If your startup has granted ISOs to employees, you must ensure that this form has been completed correctly and is filed with the IRS when these options are exercised.

Filing Form 3921 is an important process as it allows the IRS to monitor the exercise of ISOs accurately. Moreover, the IRS can ensure that the employees have correctly reported their income from the exercise of these options in their tax returns. The employees can use the data from this form to accurately determine their taxable income from the ISOs.

There is an exception to filing Form 3921 if an employee is a non-resident alien (someone who does not live in the US and is not a US citizen). This exception applies only if you need not provide the employee a Form W-2 (a wage and tax statement) for any calendar year from the time of granting the option to the exercise date. In this case, filing Form 3921 for that specific exercise is not mandatory for you.

Understanding different forms: 3921A, 3921B, and 3921C

There are three different copies of the 3921 tax form, i.e., Copy A, Copy B, and Copy C. Each copy serves a different purpose and is intended for a different recipient.

Copy A of Form 3921 has to be filed with the IRS. This copy features all details related to the transaction, including the employee details, the stock option, and the exercise. You need to complete and submit this copy timely to avoid any probable penalties or legal issues.

Copy B must go to the employee who exercised the stock options. This copy acts as a record of the transaction and provides data required to report the income from the exercise of options on their tax return. You must distribute Copy B to the employees by January 31st of the following year. This allows them enough time to file their taxes.

Copy C should be kept in your company records. This helps you keep track of the used stock options and the data that has been shared with the IRS and the employees. It is recommended that this copy be kept for four years, which is the standard period for tax documents.

How to file Form 3921?

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Filing Form 3921 involves a series of steps that you must follow accurately to ensure compliance with IRS regulations. Here are the steps on how to correctly fill out and file Form 3921:

1. The first step is to obtain the form. You can download Form 3921 from the official IRS website.
2. Next, you need to fill out the form with the necessary information. This includes details about the company, the employee, the ISOs, and the exercise of the option. Make sure to fill out all the fields accurately to avoid any potential issues.
3. File Copy A of Form 3921 with the IRS by February 28th (or April 1st if filing electronically) of the next year. You can submit the form electronically through the IRS's Filing Information Returns Electronically (FIRE) system or by mail to the address listed in the IRS instructions.
4. Copy B should be provided to the employee by January 31st of the following year. This gives the employee enough time to include this information in their tax return.
5. Finally, you should retain Copy C for your records. It is a good practice to keep this copy for at least four years, as the IRS has the power to audit the tax returns for a maximum of three years after the filing date.
6. If you are filing 250 or more Forms 3921, the IRS mandatorily requires you to file electronically. However, electronic filing is also an option if you are filing fewer forms. Electronic filing can make the process efficient and reduce the risk of errors.
7. To file electronically, you must obtain a Transmitter Control Code (TCC) by applying through the IRS Information Returns (IR) Application. The TCC code is a 5-character alphanumeric code that serves as a password for filing information returns electronically. It allows the IRS to verify the identity of the entity filing the forms.

Remember, failure to file Form 3921 or filing it incorrectly can result in penalties. Ensure you understand the filing requirements and deadlines to avoid any issues with the IRS.

What information is needed to complete the Form 3921?

Completing Form 3921 requires accurate data related to the stock option and its exercise. Here is a list of the information you will need:

• Grant Date: This is the date the incentive stock option was granted to the employee. You can find this information in the stock option agreement.
• Exercise Date: This is the date the employee exercised the option. It is the date when the employee purchased the stock at the exercise price.
• Fair Market Value (FMV) Per Share: This is the Fair Market Value of the stock on the day of exercising the option. This information can be obtained from various sources, such as your stock records or a third-party valuation provider.
• Exercise Price Per Share: This is the pre-determined price at which the employee purchased the company shares upon the ISO exercise. It is also known as the strike price and can be found in the stock option agreement.
• Total Number of Transferred Shares: This is the total number of shares the employee purchased when they exercised the option. You can find these details in the employee's stock option agreement or other equity compensation documents.

Important dates for Form 3921

There are specific deadlines that you must adhere to while filing Form 3921. This helps ensure compliance with IRS regulations. Here are the vital dates you must follow:

• January 31st: This is the last date for providing Copy B of Form 3921 to the employee who exercised the ISO. 
• February 28th: This is the deadline for filing Copy A of Form 3921 with the IRS if you are filing by paper. This copy must be submitted along with Form 1096, which serves as a transmittal form.
• April 1st: The deadline for filing Form 3921 online has been extended to April 1st for electronic filing. If you are filing 250 or more forms, you must use the electronic filing method.

The Significance of Form 3921 for Startup Employees

Form 3921 plays a vital role in establishing the cost basis for stock acquired through the exercise of ISOs. The cost basis is essentially the original value of an asset for tax purposes. In the case of ISOs, it is the exercise price paid by the employee to purchase the stock. This information, reported on Form 3921, is crucial when the employee eventually sells the stock and needs to calculate capital gains or losses.

Form 3921 also has implications for the personal tax obligations of employees. The act of an employee exercising an ISO can potentially trigger the Alternative Minimum Tax (AMT). This tax structure was established to guarantee that individuals who gain from specific exemptions, deductions, or credits contribute a minimum tax amount.

The information reported on Form 3921 is used to determine the difference (spread) between the exercise price and the FMV of the stock at the time of exercise. This spread is considered taxable income under the AMT system and needs to be reported on Form 6251.

What Happens if My Startup Doesn't File Form 3921 on Time? 

Here are the important details you must know related to these penalties as of 2024:

• If you file Form 3921 within 30 days after the due date, you will be subject to a penalty of $60 per form, up to a maximum of $630,500 per year. The maximum penalty is $220,500 for small businesses whose taxable income for the last three years is below an average of $5 million.
• If you file Form 3921 after 30 days from the deadline but before August 1st, the penalty increases to $120 per form, with a maximum of $1,891,500 per year. The maximum penalty for small businesses in this case is $630,500.
• The penalties become even more severe if you file after August 1st or never file correctly. In such cases, you will be charged $310 per form, with an annual maximum of $3,783,000. The penalty for small businesses here is $1,261,000. 
• If the IRS determines that your company intentionally disregarded the filing requirements, the penalty can be as high as $630 per form, with no annual cap.

Penalties for Incorrect Filing

Penalties also apply if you file Form 3921 with material errors, such as incorrect employee tax identification numbers or surnames. These errors can prevent the IRS from processing the form, leading to fines. The penalties for incorrect filing follow the same structure as those for late filing, with the maximum penalty increasing each year.

Failing to file Form 3921 or filing it incorrectly can have serious financial consequences for your startup. The penalties can quickly add up, diverting valuable resources away from your business operations and growth.

Conclusion

Compliance with IRS regulations regarding Form 3921 is a critical aspect of managing a startup. It helps ensure compliance with IRS guidelines and provides your employees with the vital information to manage their financial obligations effectively.

However, navigating these regulations and ensuring accurate and timely filing can be a complex task. This is where expert guidance can make a significant difference.

Qapita, a leading equity management platform, offers comprehensive solutions for managing equity matters for your company from inception to IPO. With expertise in equity management, Qapita provides a one-stop solution that over 2,400+ companies trust. Whether it's cap table management, ESOPs, valuations, or providing liquidity solutions, Qapita can help you navigate the complexities of equity management and tax compliance.

Our experts can provide you with the guidance and tools required to manage your startup's finances effectively. Contact us now!

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