Reporting Requirements for ISOs and ESPPs

Published Categorized as Tax Procedure, Tax Returns
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The IRS has released proposed Regulations to implement the recent changes in Code Sec. 6039. These Regulations require corporations to report the transfer of stock upon the exercise of incentive stock options (ISOs) and by employee stock purchase plans (ESPPs).

Pursuant to the changes in Code Sec. 6039, corporations must provide this information to the employee and, now, to the IRS by the 31st of January in the year following the transfer. The Regulations indicate that Forms 3921 and 3922 will be used for this purpose.

These Regulations may make it easier to establish the employee’s tax basis in stock acquired from ISOs and ESPPs.The option period for ISOs can be up to ten years.The option period for ESPPs can be even longer.

Prior to the recent changes in the Code, corporations were only required to provide stock transfer information to employees in the year following the transfer.On audit for the year in which the stock was eventually sold, which could be many years or decades later, employees (and the IRS) often realize that the employee has not retained these old records.

Because corporations are not able to deduct the costs of ISOs or ESPPs compensation, many corporations put little effort into providing employees with this information or retaining this information for a long period of time.This is especially true for stock options granted by under-funded start-up companies and in cases where the company has gone out of business or has been acquired by another company.

Now that this information is to be reported to the IRS, the IRS may be able to use its computer matching program to help ensure that the employee’s taxable gain on the sale of the stock is reported correctly.As a result, this may mean that ISO and ESPP-related audits may increase.This also raises questions such as will the government retain this information, how long the government will retain this information, and can the employee rely on the government to retain this information.

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