Section 6039: Historical Perspective. Agenda. Latest Updates on Section 6039 Reporting and ESPP Regulations. What is Section 6039?

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1 Agenda Latest Updates on Section 6039 Reporting and ESPP Regulations NASPP Sacramento Chapter September 8, 2010 Ed Burmeister Partner, Baker & McKenzie LLP San Francisco Section 6039 Reporting Historical Perspective New Requirements Planning for Next January ESPP Regulations Grant Date Issues $25,000 Limit Issues Separate Offering Concept Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm. 2 Section 6039 Reporting What is Section 6039? Internal Revenue Code (IRC) Section 6039 Provides for annual reporting to participants who received/transferred shares from qualified equity compensation plans (e.g., Incentive Stock Options and 423 ESPPs) To assist with filing tax returns which might be complicated due to ordinary income vs. capital gain reporting Section 6039: Historical Perspective 3 4 1

2 Section 6039 Historical Perspective Section 6039 Historical Perspective Former Requirements Every corporation which in any calendar year: transfers to any person a share of stock pursuant to such person's exercise of an incentive stock option, or records (or has by its agent recorded) a transfer of the legal title of a share of stock acquired by the transferor pursuant to his exercise of an option described in section 423(c) (relating to special rule where option price is between 85 percent and 100 percent of value of stock) must provide a written statement to each participant by January 31 of the year following the calendar year for which the activity occurred What Changed? Section 403 of the Tax Relief and Health Care Act of 2006 amended Section 6039 IRS issued proposed regulations on July 17, 2008 Regulations were finalized on November 16, 2009 Specific forms created for reporting to participants i t Requires more granular (that is per share ) information be sent to participants Information sent to participants must now be provided to the IRS New deadlines, depends on how information is submitted General Instructions for filing have been released: Section 6039 Historical Perspective Section 6039 Historical Perspective ISO Information Changes (Form 3921) Reporting Requirements Old New Name, address, and employer ID of corporation transferring stock Name and address of corporation whose stock is being transferred (if different from previous) Note: Proposed regulations also include employer ID of corporation Name, address, and ID of the employee Grant date Exercise price per share Exercise/Transfer date ESPP Information Changes (Form 3922) Reporting Requirements Old New Name and address of corporation whose stock is being transferred Note: Proposed regulations also include employer ID of corporation Name, address, and ID of the employee Grant date FMV of stock on date of grant Exercise price determined as if option were exercised on grant date Note: Required only if actual exercise price isn t known at grant Actual exercise price per share FMV of stock on date of exercise Number of shares exercised Exercise/Purchase date FMV of stock on date of exercise Total cost of all shares Type of option under which shares were acquired Purchase/Transfer date of shares Number of shares purchased/transferred Type of option under which shares were acquired 7 8 2

3 Draft IRS Forms 3921 and 3922 Section 6039: New Requirements IRS issued draft forms May 24, 2010 No significant changes expected View draft forms on NASPP website: 3921: : Instructions: ww.naspp.com/members/dlib/files/n922.pdf Final forms imminent (no changes likely) 9 10 Draft Form 3921 Draft Form

4 Filing Requirements Companies required to file 250 or more forms, must do so electronically (through FIRE system, see Pub. 1220) 250-or-more requirement applies to each form individually (not sum of both together) Before submitting through the FIRE System, you must obtain a Transmitter Control Code (TCC) from the IRS by submitting Form 4419 Allow at least 30 days for this process Information Statements to Participants Electronic delivery is permissible (sample of requirements to be met) Recipient must provide electronic consent for such delivery Scope and duration of consent must be disclosed Provide means of obtaining paper statement, if desired Ability to withdraw consent at any time Details of system requirements to access, print, and retain statements; timeframe of statement availability online Further details can be found in the General Instructions Forms Substitute Companies may deliver actual or substitute Forms 3921 and 3922 to employees Substitute Forms must include all required fields Additional rules and specifications for substitute forms will be covered under Publication 1179: Must contain all applicable form recipient instructions from official IRS form, tax year, form number, form name, OMB number, Copy B May be delivered electronically with consent of the recipient Filing Deadlines In calendar year succeeding transaction: Information Statements (to participants) January 31 Information returns (to the IRS) February 28 March 31, if filed electronically

5 Exception for filing for certain international participants No 6039 reporting for nonresident aliens if no W-2 is required for any part of calendar year between grant and exercise (ISO) or first transfer of legal title (ESPP) No carve-out for U.S. citizens working abroad even if no W-2 Penalties Failure to file with IRS Due: March 31 (if electronic) Late by 30 days or less: $15 per form; $75,000 max Late by >30 days but filed by August 1: $30 per form; $150,000 max Filed after August 1 or not at all: $50 per form; $250,000 max Penalties Failure to provide statement to employees Due: January 31 Penalty for late or no filing $50 per statement; $100,000 max Section 6039: Planning for Next January

6 Section 6039 Planning for Next January Section 6039 Planning for Next January Vendors Equity Comp Software Providers Filing information with the IRS is a complicated process, and is outside the area of expertise of most equity compensation software providers Most providers are unlikely to offer the ability to file electronically or create acceptable paper forms Issuers will need to extract information from their database and upload it into software designed to handle form creation and/or electronic filings Export files containing required information will help facilitate this annual reporting process Vendors Other All indications that payroll vendors will not provide services to assist with your 6039 requirements The IRS website lists of vendors who provide products or services that may assist you in filing Information Returns * * This publication is to provide filers with information only and in no way implies an endorsement of these products or services by the Internal Revenue Service Section 6039 Planning for Next January Section 6039 Planning for Next January Vendors Other Several vendors will offer the following: Electronic filing capabilities (with the IRS) Ability to print official forms to be submitted to the IRS and distributed to participants Print and mail services (to participants) Ability to assist you with requesting Transmitter Control Code (TCC) from the IRS What You Need to do to Get Ready Establish a project plan for both the participant communication and the IRS filing Determine in what way your equity compensation software will be able to assist you Research and engage external vendor(s), if necessary Establish an internal and participant communication plan Create any additional participant communication documents Obtain a Transmitter Control Code (TCC) from the IRS by submitting Form 4419 * * * *

7 ESPP Regulations ESPP Regulations Section 423 Regulations Grant Date Design Considerations Administrative Considerations Offerings Design Considerations Non-US Employees $25,000 Limitation Administrative Considerations Design Considerations Operational Errors Other Areas Section 423: Grant Date Section 423 Grant Date Section 423 Grant Date Grant Date For offering begin date to be considered the grant date, maximum number of shares an employee can purchase must be fixed and determinable when the offering starts Formula determination is okay, so long as number of shares purchasable under the formula can be calculated at beginning of offering $25,000 limit and aggregate shares available in the plan are insufficient to establish grant date If no per-person maximum, grant date is considered to be the purchase date Design Considerations Why is grant date important for ESPPs? Allows lookback to beginning of offering period for lower of 85% price Starts two-year holding period for disqualifying disposition purposes Determines FMV of shares for calculating $25,000 limit Key to calculation of compensation income upon qualifying disposition Final Regulations reiterate importance of grant date and clarify requirements to determine it

8 Section 423 Grant Date Section 423 Grant Date Design Considerations How to make sure beginning of offering period is grant date: State maximum number of shares any employee can purchase (e.g., 1,000 shares). Final Regulations permit any number within overall plan limit, does not have to be realistic. Provide a formula that fixes maximum number of shares for each offering period. (Can use a formula derived from $25,000 limit, but needs to pin down maximum for each offering). If not in Plan document, may satisfy with Board/Committee resolution (check Plan for authority). Design Considerations What grant date makes sense if purchase price determined on purchase date (no lookback)? What to do if offering began January 1 with no fixed or determinable number of shares? Section 423 Grant Date Section 423 Grant Date Administrative Considerations Companies must establish an employee share limit within an offering period Failure to do so will impact the determination of date of grant and may result in the following: Impact in calculating the $25K limit Delay in the start of the two year holding period (from date of grant) Calculating compensation income Grant Date FMV, which is a required field on Form 3922 Employees may not be aware of these changes, consider communications that alert them of any impact Administrative Considerations Impact to holding period

9 Section 423 Offerings Offerings Section 423: Offerings A plan may include one or more offerings Consecutive or overlapping Terms of offerings do not need to be identical Company may designate which subsidiaries are eligible to participate in each offering Offering can qualify for Section 423 treatment if operated in compliance with the regulations, even if plan, as written, does not qualify Disqualification of one offering from Section 423 treatment does not necessarily impact status of other offerings under the plan Section 423 Offerings Section 423 Offerings Design Considerations Designating separate offerings Why do this? Permits local variations by corporate entity e.g., inclusion of part-timers in Europe; direct contribution (no payroll deductions) in Hong Kong or Argentina Walls off by entity the effect of noncompliant offer e.g., some eligible employees or an entity inadvertently excluded Design Considerations Designating separate offerings (cont.) How to do this? Could be set forth in Plan Could be by Board/Committee resolution (but be sure authority is clear in the Plan)

10 Section 423 Non-US Employees Non-US Employees Section 423: Non-US Employees Employees of foreign subsidiary can participate in separate offerings under same plan as US employees Different terms than offering for US employees Non-US employees of US entity (rather than foreign subsidiary) must be allowed to participate in same plan/offering as US employees Unless local law prohibits participation Can be provided fewer rights than US employees, but only if required under local law Cannot be provided greater rights than US employees, even if required under local law Section 423 $25,000 Limit $25,000 Limitation Section 423: $25,000 Limit Final regs allow for liberal interpretation Where offering spans a calendar year, unused purchase limit from prior calendar years carries forward, even if purchase is not permitted in those years Reversal of proposed regs

11 Section 423 $25,000 Limit Section 423 $25,000 Limit Administrative Considerations Before proposed and final regulations, different interpretations resulted in inconsistencies within industry East coast companies typically used a conservative approach, while those on the west coast took the liberal approach With the clarifications of final regs, companies need to ensure they are in compliance Ensure your service provider or administration software either supports the final regs or has plans to do so Administrative Considerations The above example uses a two-year offering period, with purchase every six months In 2009, the offering period is outstanding, but no purchase events Since offering was outstanding in 2009, any unused balance can be carried over to 2010 (and subsequently into 2011) If employee purchased $10,000 in 2009 (under the prior offering), he/she should be able to then purchase $40,000 in 2010 $40,000 = $15,000 (remaining from 2009) + $25,000 (for 2010) Any unused portion of the $40,000 can then be carried into Section 423 $25,000 Limit Design Considerations Action items re $25,000 limit Possible need to amend plan if plan uses conservative limit and company wants to use liberal rule Possible need to amend plan if plan document simply tracks Code but company wants to apply more conservative rule Be sure plan, employee communications and vendor or company software calculation are all consistent Common questions re application of Limit Section 423: Operational Errors

12 Section 423 Operational Errors Operational Errors Operational errors with respect to eligibility and participation Disallowing eligible employees to participate disqualifies entire offering Allowing ineligible employees to participate does not disqualifying offering (although purchases by those employees are disqualified) Allowing purchase that violates terms of the plan or offering disqualifies the purchase in question but does not disqualify the offering Section 423: Other Areas Section 423 Other Areas Other Areas Covered under the Regs Shareholder approval of plans Carry-forward of unused contributions from prior offerings Effective for options granted after January 1, 2010 Questions? Contact Info Edward D. Burmeister Partner, Baker & McKenzie, LLP San Francisco (415) (Note: new )