Notice Requirements for Purchases under Incentive Stock Options and ESPPs—Immediate Action Needed

Notice Requirements for Purchases under Incentive Stock Options and ESPPs—Immediate Action Needed



Pr actitioners and stock plan administrators appear to be taking a variety of positions with respect to compliance this month with newly effective reporting requirements for employee stock purchase plans (ESPPs) under Section 423 of the Internal Revenue Code (the Code) and incentive stock options (ISOs) under Code Section 422. We recommend that companies either (i) mail a notice under the new rules to current and former employees who are covered by these reporting requirements, or (ii) file an extension request with the IRS. We understand that the IRS may consider providing compliance relief or further guidance on this notice requirement, but, since the current deadline appears to be Monday, January 31, we recommend proceeding without waiting for any compliance relief.

Who is Affected?

Corporations that maintain ESPPs and corporations that grant ISOs are affected, if, in 2004, their current or former employees either purchased stock by exercising an ISO or purchased (or in some cases transferred) shares under an ESPP. Each purchase or transfer is, for purposes of this alert, a "triggering event." In general, the IRS can impose a penalty of $50 for each statement that is not sent on time or that contains incomplete or incorrect information, up to a maximum penalty of $100,000 per calendar year.

Note that, for ESPPs, the triggering event is the first transfer of legal title by the participant. In practice, this often occurs when a brokerage firm administering the plan takes title to the shares initially after purchase. However, if the corporation issues shares directly to participants, it occurs with the participants' first transfer of title. Because tracking can be complicated, the rules also require a corporation that sells shares under an ESPP to identify that stock in a manner that allows it to track the initial transfer of the stock (such as by use of a certificate number or other share coding).

What Notice is Required?

Code Section 6039(a) requires corporations to send a written statement that provides certain specified information to each employee (or former employee) who engaged in a triggering event. These notices are required to be given on or before January 31 of the year following the triggering event. Although Section 6039 has been in the Code for a number of years, many companies have not complied, because the IRS issued informal guidance that delayed the notice requirements until after final ISO regulations were issued. In 2004, the IRS issued final ISO regulations, but those regulations contained ambiguous transition rules. Even though some corporations may choose to interpret the transition rules to delay the notice requirements until next year, we recommend taking action now.

The notice should include the following items:

Incentive Stock Options (ISOs)

Employee Stock Purchase Plans (ESPPs)

Name, address, and tax identification number of the employer and the corporation of the stock subject to the option

Name and address of the corporation whose stock is transferred

Name, address, and tax identification number of the optionee

Name, address, and tax identification number of the employee

Date the option was granted


Date the option was exercised

Date the stock was purchased

Number of shares exercised [i.e., purchased]

Number of shares for which title was transferred in 2004

Type of option that was exercised [i.e., incentive stock option]

Type of option under which the shares were acquired [i.e., an option issued under an employee stock purchase plan]

Total cost of the shares


Market value of the shares at the time of exercise


What Action Should be Taken?

Confirm compliance. For companies that use stock transfer agents, the first step should be to contact the agent (or a plan administrator) to determine whether anyone has already provided the employees with notices that contain the required information. Although the regulations do not provide for anyone other than the corporation to give the ISO notice (or anyone other than the corporation or its stock transfer agent to give the ESPP notice), the corporation will be in a better compliance position if someone has provided the information. Note that Section 6039 does not require filing with the IRS.

Seek an extension. If providing notices immediately is not practical, we would recommend filing an extension (on Monday) with the IRS. We have included a letter at the end of this alert, for use in requesting a 30-day extension (the maximum amount currently permitted).

Send the notices. Companies with only a few employees with triggering events may want to file the notices on Monday, by either hand-delivering them to the employees or mailing them to the employees' last known addresses. (Electronic delivery is possible, but requires prior consent.) Plan administrators should be able to generate the information for these forms, as should most or all in-house administration software programs.

What is the Purpose of the Information Statements?

The information statements are intended to assist employees in determining their alternative minimum tax and other tax attributes associated with receiving and disposing of the shares. They do not take the place of any reporting obligations the corporations may have with respect to disqualifying dispositions of ISO shares or shares received under ESPPs. For example, corporations will still be required to report the income from a disqualifying disposition on a Form W-2 to deduct the compensation.

For more information on this alert and how it applies to your compensation programs, please contact the attorneys listed above.


[Company Letterhead]

Certified Mail

Return Receipt Requested

January ___, 2005

Martinsburg Computing Center

Attn: Extension of Time Coordinator

250 Murall Drive

Kearneysville, West Virginia 25430


Re: [Company Name]

EIN: _____________


To Whom It May Concern:

Pursuant to regulation 1.6039-1(c)(2), [Company Name] hereby requests a 30-day extension for filing any required notices under section 6039 of the Internal Revenue Code. Such extension is requested because [insert reason for needing the extension].

Please confirm that an extension has been granted by returning a copy of this letter to my attention, using the enclosed self-addressed stamped envelope or by means of such other form as is routinely used for such extensions.





Extension Granted to ___________________