Class A to American Depositary Share (ADS) conversion

[Jwfang]

I’d like some advice on how to file for the following scenario:

1) I was issued ISO stock options at employee at a foreign pre-IPO startup company.

2) I left that company before they IPOed. I decided to exercise my options and purchased them at a cost basis of $0.10 / share. At the time there was no difference in value between what I paid and fair market value, so I did not have to pay additional taxes. I received a Form 3921 from that company and filed this transaction in my taxes the following year. Note this transaction starts the 1 year clock of ownership to qualify as a long term capital gains sale.

3) 2 years after I purchase those Class A shares, the company just went IPO, listed on NASDAQ using American Depositary Shares (ADS). The former company has informed me that the Class A shares will convert to ADS shares at a 4:1 ratio.

4) I now plan to sell those ADS shares.

Question:

1) How do I report the income of the sale of ADS shares? Does this receive long term capital gains treatment? How does the IRS associate that I held those shares for more than 1 year (as filed in my previous year return and also disclosed in the 3921)  to my ADS sale?
2) What do I report as the tax basis? Since it’s 4 class A shares : 1 ADS share, is that $0.40 / share? How do I do this TurboTax?

[TomYoung · Accepted solution]

"I received a Form 3921 from that company and filed this transaction in my taxes the following year."

I really don't know what that means.  I assume you made some sort of entry for AMT purposes even though there was no "spread" between what you paid and FMV?   That is, the actual adjustment was $0?  (The entry should have really been made in the year you exercised as it's not selling all the stock acquired via an ISO in the year of acquisitions that triggers AMT.)  There's no other way to "file" a Form 3921 that I'm aware of.

"1) How do I report the income of the sale of ADS shares? Does this receive long term capital gains treatment? How does the IRS associate that I held those shares for more than 1 year (as filed in my previous year return and also disclosed in the 3921) to my ADS sale?"

This is strictly a seat of the pants answer without any sort of cite, but I don't see any problem at all, you simply report the sale of the ADS and indicate the purchase date, back before the IPO.  The 4:1 ratio of "stock" to ADS seems to be nothing more than a "stock split", from your perspective.  Given the time gap it sure is a long term capital gain.  I would guess the IRS wouldn't even try to "associate" the sale with the Form 3921. 

If the IRS ever asks about the sale, I'd bet money and give you odds that they won't, you explain things to them.

"2) What do I report as the tax basis? Since it’s 4 class A shares : 1 ADS share, is that $0.40 / share? How do I do this TurboTax?

If it takes 4 shares of stock to get one ADS then, yep, your basis is $.40 per ADS.  The easiest way to "do this" in TurboTax is to simply fill in the "Cost or other basis" box on the standard "1099-B" entry form TurboTax presents to you in the interview.  There's no need to show any detail when reporting a security sale.   Again, if the IRS ever asks about the sale, you explain how you calculated the basis, and you're done.

[Jwfang]

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@TomYoung wrote:

I assume you made some sort of entry for AMT purposes even though there was no "spread" between what you paid and FMV?   That is, the actual adjustment was $0?  (The entry should have really been made in the year you exercised as it's not selling all the stock acquired via an ISO in the year of acquisitions that triggers AMT.)  There's no other way to "file" a Form 3921 that I'm aware of.

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That is correct.

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@TomYoung wrote:

This is strictly a seat of the pants answer without any sort of cite, but I don't see any problem at all, you simply report the sale of the ADS and indicate the purchase date, back before the IPO.  The 4:1 ratio of "stock" to ADS seems to be nothing more than a "stock split", from your perspective.  Given the time gap it sure is a long term capital gain.  I would guess the IRS wouldn't even try to "associate" the sale with the Form 3921. 

If the IRS ever asks about the sale, I'd bet money and give you odds that they won't, you explain things to them.

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Except that this isn't exactly a stock split, because I'm exchanging one type of share for another. Does my organization need to file form 8937?

https://www.irs.gov/forms-pubs/about-form-8937

File Form 8937 if you are an issuer of a specified security that takes an organizational action that affects the basis of that security. A specified security is:

• Any share of stock in an entity organized as, or treated for federal tax purposes as, a corporation;

• Any interest treated as stock, including, for example, an American Depositary Receipt

Does an IPO event of an ADS share, with a defined conversion ratio count as an "organizational action that affects the basis of that security"?

[TomYoung]

A Form 8937 might be required here though I really have no idea if this particular event will result in one.  I see that the Form 8937 instructions also include this sentence: "You do not need to file Form 8937 for an initial public offering or an issuance of a debt instrument."

But if you've accurately described all the events surrounding this particular stock/ADS then the derivation of the basis of the ADS when you sell seems trivial.  Since the ADS are trading on NASDAQ I'd think the company would have some sort of "Investor relations" department, so you should be able to ask them if a Form 8937 will be filed.