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Filing your taxes after exercising and holding private startup shares

If you’re reading this article, you’ve probably worked or are working at a private startup for more than a year, have exercised and held your employee incentive stock options, and received form 3921 from your employer. It’s time to file your taxes for the year, and you’re not sure what to do.

You’ve endlessly searched through your online tax program (H&R Block, TurboTax, etc.) without luck. The form 3921 you received doesn’t tell you what to do next. You’re slowly realizing that nobody on the web is documenting this process well, or providing any sort of step-by-step assistance.

I went through this scenario in the (2016) tax season, researched what to do, and now have a burning desire to share this information with fellow startup employees living across the US, who’ve found themselves in a similar scenario.

Step-by-Step Recap

Let’s recap your scenario, to make sure we’re on the same page. This is the step-by-step incidence of what’s happened thus far:

1. Worked at a private startup for more than 1 year.

2. Took a leap of faith and exercised stock options granted to you by your startup.

3. Held the exercised shares – meaning you haven’t sold your purchased shares on any public or secondary markets.

4. Received form 3921 from your employer.

5. You’re now ready to file your taxes.

Great. Now that we’re on the same page, let’s learn about form 3921.

What is form 3921 and why did I receive it?

Form 3921 is your personal copy of a form generated by the startup company with which you’ve exercised your stock options.

This form will help you make some basic calculations required for the next set of instructions in this posting; but for now, let’s learn a little bit more about form 3921:

There are two other copies of form 3921 in existence, one that is held by your employer and another which is sent to the IRS (by your employer). Companies are required by law to provide you with a copy of form 3921 by January 31st of following year in which you’ve exercised or purchased your options.

From the IRS’ perspective, this form ensures that they’re aware you’ve exercised the stock options granted to you by your employer, along with any unrealized gains or losses associated with that purchase.

An unrealized gain or loss is a fancy way to say that on paper you’ve purchased something (in this case, shares of a company) at a certain price, and that it’s now valued either higher or lower than the original price you paid. The “unrealized” part of this term means that you haven’t actually sold the stock option for cash, and haven’t “realized” the fiscal gain or loss.

Let’s take a look at the information found on form 3921:

Box 1 – Date of Options Granted The date you were granted your options. This is typically the day you started working at this startup or the day they gave you more options as reward or incentive to stay.

Box 2 – Date of Options Exercised The date you exercised or purchased your options.

Box 3 – Exercise Price Per Share The price at which your startup sold these shares to you.

Box 4 – Fair Market Value Per Share on Exercise Date The FMV (fair market value) per share on your exercise date.

Box 5 – Number of Shares Transferred These are the number of shares you’ve purchased from your startup.

Box 6 – If Other Than TRANSFEROR, Name, Address, and EIN of Corporation Whose Stock Is Being Transferred Information about the company who is transferring the stock to you.

Where do I enter form 3921 into my tax program (H&R Block, TurboTax, etc.)?

Most pieces of basic tax documentation you receive is found on forms which match similar box inputs found in online tax programs. For example, you receive a W-2 for wages from your employer and your tax program automatically has you inputting, box-for-box, the information found on your W-2. 

Form 3921 is similar if you’re using TurboTax, but different if you’re filing your taxes manually, using H&R Block, or using another online tax filing program.

The information found on form 3921 is only meant to help you figure out a basic calculation. This calculation is then entered into form 6251 – Alternative Minimum Tax – Line 14 Exercise of incentive stock options.

Please skip the form 3921 calculation section below if you’re using TurboTax, and jump directly to the step-by-step instructions.

Calculating your adjustment using form 3921

Step 1: Multiply the figure found in Box 4 by the figure found in Box 5. The calculation tells you how much the shares you’ve exercised are worth right now.

Step 2: Multiple the figure found in Box 3 by the figure found in Box 5. The calculation tells you how much your shares were worth when they were granted to you AND how much you paid to exercise these shares.

Step 3: Subtract the calculation from step 1 from calculation in step 2. This new calculation gives you a dollar amount that is your “adjustment”. You’ll be entering this adjustment into our next set of instructions.

How do I enter this calculation into form 6251 – Line 14 using my tax program?

TurboTax’s user interface handles this scenario much easier than H&R Block’s, so I recommend using TurboTax. TurboTax has a section labeled “ISO Exercise and Hold” found within the “Wages & Income” section of your federal tax returns, and walks you through the process of entering the information found in your 3921 form.

H&R Block requires you to find form 6251 and enter the adjustment calculation we made in the step above.

TurboTax Step-by-Step (Recommended)

1. Begin filing your taxes as normal by entering any W-2 wages, etc.

2. Within “Federal Taxes” -> “Wages & Income” scroll down the page until you see the drop down “Investment Income”.

3. Within the “Investment Income” section click the Start button found the right of “ISO Exercise and Hold”.

4. You’ll need to purchase TurboTax Deluxe on-screen for $34.99 in order to continue with this process.

5. The rest of the process is easily followed on the website, where you’ll enter the information found in form 3921.

Note: Even though you’ll be entering this information into your “Wages & Income” section on TurboTax, it will not be counted as as income tax for the year, it will still be considered an adjustment on your AMT (Alternative Minimum Tax).

H&R Block Step-by-Step

1. Begin filing your taxes as normal by entering any W-2 wages, etc within the “Income” icon found under the “Federal” tab.

2. After you’ve completed the “Adjustments & Deductions” and “Credits” sections, you’ll get to the “Taxes” section.

3. You’re going to need to add information into the “Taxes” section, and you’ll be presented with a list of drop-down options.

4. Click on the drop-down option “Estimated Taxes and Other Taxes, Payments and Penalties”.

5. Click on the “Visit Topic” button for “Alternative Minimum Tax (AMT) adjustments (Form 6251)

6. You’ll be presented with a screen of check-boxes; check the box that says “Exercised incentive stock options” and click the “Next” button.

7. Now it’s time to enter the calculation we made from above into the “Incentive stock option adjustment” box and continue through the rest of the screens.

What is AMT (Alternative Minimum Tax) and how does it work?

The reason AMT was originally enacted, was to target 155 high-income households that were using exemptions, credits, and deductions to not pay any taxes at all.  Today, AMT now affects millions of families each year, and is continuing to grow. In 1997, 605,000 taxpayers paid the AMT and by 2008, 3.9 million, or about 4% of all individual taxpayers paid the AMT.

An alternative minimum tax (AMT) recalculates income tax after adding certain tax preference items back into adjusted gross income. AMT uses a separate set of rules to calculate taxable income after allowed deductions.

If you’re filing your taxes manually and not using one of the mainstream tax programs described above, the only way to really figure out if you owe the AMT is to do your taxes twice – once with the AMT and one under the standard (1040) IRS rules.

AMT Example

The simplest explanation is that the government will take the highest of your two amounts: Your regular federal tax or your Alternative Minimum Tax rate.

Let’s say you do your taxes and calculate that your tax for the year is at $20,000. Alternatively, your tax under the Alternative Minimum Tax rates is only $15,000. Since your AMT is lower than your normal tax, you do not have to pay the AMT.

Alternatively, what if you were to calculate your taxes using traditional tax rules and it is $20,000, but under AMT rules your tax is $25,000? In this scenario you would be subject to AMT rules and have to pay the greater of the two ($25,000).

For more information about Alternative Minimum Tax, please see:

Wikipedia (Alternative Minimum Tax): https://en.wikipedia.org/wiki/Alternative_minimum_tax

IRS: https://www.irs.gov/individuals/alternative-minimum-tax-assistant-for-individuals

Disclaimer & disclosure: I’m not an accountant or a lawyer, the information above comes from my personal experience only. Please seek the help of qualified professionals to help you with your personal situation.