IRS Announces Intent to Impose Payroll Taxes on Incentive & Stock Option Employee Stock Purchase Plans
January 2001
On January 18, 2001, the IRS issued mixed news for employers who maintain statutory stock option plans by postponing the imposition of payroll taxes on such plans.
As described in detail in our October 2000 On the Subject entitled, "The Longstanding Payroll Tax Exemption for Statutory Options May Be Eliminated," the IRS is moving toward imposing income tax withholding on disqualifying dispositions of shares acquired pursuant to the exercise of an incentive stock option (ISO), as well as to shares acquired pursuant to an employee stock purchase plan (ESPP). In addition, the IRS also appears to be heading toward imposing employment tax withholding on the entire spread at exercise of a statutory option.
Unfortunately, on January 18, the IRS issued (click here^)Notice 2001-14, which confirms its intent to change the longstanding rule and begin to impose payroll taxes on option plans. Notice 2001-14 outlines the IRS' intent to assess employment taxes (Federal Insurance Contributions (FICA) or Federal Unemployment Tax (FUTA)) upon the exercise of any statutory option, as well as to treat the early disposition of shares acquired by an employee pursuant to the exercise of a statutory option as subject to income tax withholding.
The only welcome news in Notice 2001-14 is that the IRS will delay the implementation of these changes. Specifically, options exercised prior to January 1, 2003 (regardless of when the shares are actually sold) will not be subjected to payroll taxes. Further, with respect to statutory options exercised prior to January 1, 2003, the IRS will not assert penalties or interest and will honor otherwise allowable adjustments and claims for refund of any employment taxes previously paid.
