IRS and U.S. Department of the Treasury Grant Stock Option Relief
June 2002
Through previous client communications, McDermott Will & Emery has kept clients and friends apprised of the IRS and the U.S. Department of the Treasury’s efforts to impose payroll taxes and additional administrative burdens on employers by overturning the 30-year-old payroll tax exemption accorded to statutory stock options, more commonly referred to as incentive stock options (ISOs) and employee stock purchase plans (ESPPs). Although the IRS issued adverse guidance in fall 2001 that would have imposed new payroll taxes and significant administrative compliance burdens beginning in 2003, the IRS invited written comments and oral testimony at an IRS hearing. In that respect, there is some positive news to report.
Lawyers in McDermott Will & Emery’s Fringe Benefits and Payroll Tax Practice submitted written comments and then testified at the IRS public hearing in May 2002 on behalf of our adversely impacted clients and
their employees. Along with others who testified, we voiced strong disagreement with the IRS’ apparent decision to reverse the longstanding favorable and reasonable tax position taken for statutory stock options for the past three decades. We strongly encouraged the IRS and the Treasury to reconsider their position and to adopt the more reasoned and practical approach taken for other equally thorny issues, such as its recently released guidance on frequent flyer miles.
We also urged the IRS and the Treasury that, if they decided not to follow the same practical approach, additional time should be provided to employers beyond the January 1, 2003, deadline to rework the many computer and payroll tax systems that would be affected by these new withholding and deposit requirements. We informed the IRS that employers needed more time to assess their internal systems, determine and implement the necessary changes, work with various outside service providers, communicate to employees and resolve administrative problems that would undoubtedly be encountered.
After receiving our testimony and written comments, and those of other interested parties, the IRS and the Treasury announced on June 25 that they have extended the moratorium on the proposed imposition of employment taxes for a minimum of two years in order to provide adequate time to consider all the complex issues raised by the submitted comments. Likely playing into this administrative relief were the various legislative efforts underway to exempt statutory stock options from payroll taxes.
More specifically, the IRS issued Notice 2002-47 (click here^ to view) indicating that, until further guidance is issued, the IRS will not impose FICA tax, FUTA tax or federal income tax withholding on any exercise of a statutory stock option or the disqualifying disposition of stock acquired pursuant to the exercise of such an option. Recognizing that employers and statutory stock option plan administrators will need adequate time to implement any guidance ultimately provided, the notice also indicates that any imposition of employment taxes should not apply earlier than the January 1 of the year that follows the second anniversary of the publication of final guidance. The notice does not affect an employer’s current Form W-2 reporting obligations regarding disqualifying dispositions of such stock.
We are hopeful that the IRS, as part of its ongoing reconsideration, may totally abandon its attempts to impose these new payroll taxes on ISOs and ESPPs.
