[Federal Register Volume 66, Number 220 (Wednesday, November 14, 2001)]
[Proposed Rules]
[Pages 57023-57028]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-28535]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 31
[REG-142686-01]
RIN 1545-BA26
Application of the Federal Insurance Contributions Act, Federal
Unemployment Tax Act, and Collection of Income Tax at Source to
Statutory Stock Options
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to
incentive stock options and options granted under employee stock
purchase plans. These proposed regulations would provide guidance
concerning the application of the Federal Insurance Contributions Act
(FICA), Federal Unemployment Tax Act (FUTA), and Collection of Income
Tax at Source to these options. These proposed regulations would affect
employers that grant these options and employees who exercise these
options. This document also provides notice of a public hearing on
these proposed regulations.
DATES: Written or electronic comments and outlines of topics to be
discussed at the public hearing scheduled for March 7, 2002, must be
received by February 14, 2002.
ADDRESSES: Send submissions to: CC:ITA:RU (REG-142686-01), Room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG 142686-01),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue,
NW., Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.gov/tax_regs/reglist.html. The public
hearing will be held in the Auditorium of the Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Stephen Tackney of the Office of Division Counsel/Associate Chief
Counsel (Tax Exempt and Government Entities), (202) 622-6040;
concerning submissions of comments, the hearing, and/or to be placed on
the building access list to attend the hearing, Treena Garrett, (202)
622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Employment Tax
Regulations (26 CFR part 31) under sections 3121(a), 3306(b), and
3401(a) of the Internal Revenue Code of 1986 (Code), and to the Income
Tax Regulations (26 CFR part 1) under section 424 of the Code. These
regulations would clarify current law regarding FICA tax, FUTA tax, and
income tax withholding consequences upon the exercise of statutory
stock options, i.e., incentive stock options described in section
422(b) and options granted under an employee stock purchase plan
described in section 423(b). FICA tax consequences are determined by
sections 3101 through 3128, FUTA tax consequences by sections 3301
through 3311, and income tax withholding consequences by sections 3401
through 3406.
A. Statutory Stock Options
Section 422(b) sets forth the requirements for treatment of options
as incentive stock options. If certain conditions are met, special tax
treatment is provided in section 421(a) for the transfer of stock to an
individual
[[Page 57024]]
pursuant to the exercise of an incentive stock option. These conditions
include a requirement that the individual not dispose of the stock
within two years from the date of the grant of the option, and a
requirement that the individual not dispose of the stock within one
year after the transfer of the stock to the individual.
Section 423(b) sets forth the requirements for establishment of an
employee stock purchase plan. If certain conditions are met, special
tax treatment is provided under section 421(a) for the transfer of
stock to an individual pursuant to the exercise of an option granted
under an employee stock purchase plan. These conditions include a
requirement that the individual not dispose of the stock within two
years from the date of the grant of the option, and a requirement that
the individual not dispose of the stock within one year after the
transfer of the stock to the individual.
Section 421(a) provides that at the time stock is transferred to an
individual pursuant to the exercise of an option, if the conditions of
section 422(a) or 423(a) are met, then no income to the individual
results upon the exercise. Section 421(b) provides that at the time
stock is transferred to an individual pursuant to the exercise of an
option, if the stock is sold or disposed of by the individual and the
holding period requirements of section 422(a)(1) or 423(a)(1) are not
met, then any income to the individual which results for the taxable
year, in which the option was exercised, attributable to the sale or
disposition of the stock is income to the individual in the taxable
year, of the individual, in which the sale or disposition occurred.
Section 423(c) provides guidance when the option price of a share
of stock acquired by an individual pursuant to the exercise of an
option granted under an employee stock purchase plan is less than 100
percent of the fair market value of the share at the time the option
was granted. Section 423(c) provides that in the event of either the
disposition of the share of stock by the individual which meets the
holding period requirements of section 423(a) or in the event of the
individual's death while owning the share of stock, that any resulting
compensation is attributable to the individual in the taxable year in
which the disposition or death occurred. The compensation attributable
to the individual is the amount equal to the lesser of (1) the excess
of the fair market value of the share at the time of the disposition or
death over the amount paid for the share under the option or (2) the
excess of the fair market value of the share at the time the option was
granted over the option price.
B. FICA, FUTA, and Income Tax Withholding
1. FICA
FICA tax is generally imposed on each employer and employee. Under
section 3111, FICA tax is imposed on the employer in an amount equal to
a percentage of the wages paid by that employer. Under section 3101,
FICA tax is also imposed on the employee in an amount equal to a
percentage of the wages received by the employee with respect to
employment.
FICA tax is composed of a tax for Old-Age, Survivors, and
Disability Insurance (OASDI) and a tax for Hospital Insurance (HI). The
OASDI portion of FICA tax is imposed separately on the employer and on
the employee in an amount equal to 6.2 percent of wages. Under section
3121(a)(1), the wages subject to the OASDI portion of FICA tax are
limited to the contribution and benefit base for OASDI for that year
($80,400 for calendar year 2001). The HI portion of FICA tax is
separately imposed on the employer and the employee in an amount equal
to 1.45 percent of wages. There is no dollar limit on the wages subject
to the HI portion of FICA tax.
Under section 3102, the employer is required to collect the
employee portion of FICA tax by deducting the amount of the tax from
wages, as and when paid, and is liable for payment of the tax required
to be collected. Under Sec. 31.3102-1(a) of the Employment Tax
Regulations, the employer is required to collect the employee portion
of FICA tax, notwithstanding that the wages are paid in something other
than money, and to pay over the tax in money.
2. FUTA
FUTA tax is generally imposed under section 3301 on each employer
in an amount equal to a percentage of wages paid by the employer with
respect to employment. FUTA tax is imposed on the employer in an amount
equal to 6.2 percent of wages. Under section 3306(b), wages of an
employee subject to the FUTA tax are limited to $7,000 per calendar
year.
3. Income Tax Withholding
Income tax withholding is imposed under section 3402(a), which
requires employers paying wages to deduct and withhold income tax on
those wages. The amount deducted and withheld is determined in
accordance with tables or computational procedures prescribed by the
Secretary of the Treasury.
C. Wages
1. FICA
For FICA purposes, section 3121(a) provides that the term wages,
with certain exceptions, means all remuneration for employment,
including the cash value of all remuneration (including benefits) paid
in any medium other than cash. Similarly, under Sec. 31.3121(a)-1(b),
the term wages means all remuneration for employment unless
specifically excepted under section 3121(a) or Sec. 31.3121(a)-1(j).
Neither the Code nor the regulations contain an exclusion from wages
for the value of stock transferred pursuant to the exercise of an
option.
Under Sec. 31.3121(a)-1(e), in general, the medium in which the
remuneration is paid is immaterial. It may be paid in cash or in kind.
The amount of non-cash remuneration is based on the fair market value
of the non-cash remuneration at the time of payment.
Under Sec. 31.3121(a)-1(a), in general, wages are received by an
employee at the time that they are paid by the employer to the
employee. Wages are generally paid by an employer at the time that they
are actually or constructively paid.
Under Sec. 31.3121(a)-1(i), remuneration for employment, unless
specifically excepted under section 3121(a) or Sec. 31.3121(a)-1(j),
constitutes wages even though at the time paid the relationship of
employer and employee no longer exists between the person in whose
employ the services were performed and the individual who performed
them.
2. FUTA
For FUTA purposes, section 3306(b) provides that the term wages,
with certain exceptions, means all remuneration for employment,
including the cash value of all remuneration (including benefits) paid
in any medium other than cash. Similarly, under Sec. 31.3306(b)-1(b),
the term wages means all remuneration for employment unless
specifically excepted under section 3306(b) or Sec. 31.3306(b)-1(j).
Neither the Code nor the regulations contain an exclusion from wages
for the value of stock transferred pursuant to the exercise of an
option.
Under Sec. 31.3306(b)-1(e), in general, the medium in which the
remuneration is paid is immaterial. It may be paid in cash or in kind.
The amount of non-cash remuneration is based on the fair market value
of the non-cash remuneration at the time of payment.
[[Page 57025]]
Under Sec. 31.3301-4, wages are considered paid when actually or
constructively paid.
Under Sec. 31.3306(b)-1(i), remuneration for employment paid by an
employer to an individual for employment, unless specifically excepted
under section 3306(b), constitutes wages even though at the time paid
the individual is no longer an employee.
3. Income Tax Withholding
For income tax withholding purposes, section 3401(a) provides that
the term wages, with certain exceptions, means all remuneration for
services performed by an employee for his employer, including the cash
value of all remuneration (including benefits) paid in any medium other
than cash. Similarly, under Sec. 31.3401(a)-1(a), the term wages in
general means all remuneration for employment for services performed by
an employee for his employer unless specifically excepted under section
3401(a) or 3402(e).
Under Sec. 31.3401(a)-1(a)(4), in general, the medium in which the
remuneration is paid is immaterial. It may be paid in cash or in kind.
The amount of non-cash remuneration is based on the fair market value
of the non-cash remuneration at the time of payment.
Under Sec. 31.3402(a)-1(b), the employer is required to collect the
tax by deducting and withholding the amount from the employee's wages
as and when paid, either actually or constructively.
Under Sec. 31.3401(a)-1(a)(5), remuneration for services, unless
specifically excepted by statute, constitutes wages even though at the
time paid the relationship of employer and employee no longer exists
between the person in whose employ the services were performed and the
individual who performed them.
The legislative history of sections 3401 through 3404 indicates
that a purpose of income tax withholding is to enable individuals to
pay income tax in the year in which the income is earned. H.R. Conf.
Rep. No. 78-510 at 1 (1943); H.R. Rep. No. 78-401 at 1 (1943); Rep. No.
78-221 at 1 (1943); and Senate Rep. No. 78-221 at 1 (1943). Therefore,
income tax withholding is generally imposed only upon remuneration paid
by an employer to the extent that an employee recognizes income.
Section 421(a) provides that if a share of stock is transferred to an
individual in a transfer which meets the requirements of section 422(a)
or 423(a), no income is recognized at the time of the transfer.
As part of the Social Security Amendments of 1983, Public Law 98-
21, 97 Stat. 65 (1983), Congress amended sections 3121(a) and
3306(b)\1\ to provide specifically that regulations providing an
exclusion from wages for income tax withholding purposes are not to be
construed to require a similar exclusion from wages for FICA and FUTA
purposes. The legislative history to the Social Security Amendments of
1983 at S. Rep. No. 98-23, 42, 98th Cong., 1st Sess. explains as to
FICA and income tax withholding that ``[S]ince, [however], the [social]
security system has objectives which are significantly different from
the objective underlying the income tax withholding rules, the
committee believes that amounts exempt from income tax withholding
should not be exempt from FICA unless Congress provides an explicit
FICA tax exclusion.'' The legislative history further explains that
Congress intended to reverse the holding in Rowan Companies v. U.S.,
452 U.S. 247 (1981), that the definitions of wages for FICA and income
tax withholding purposes were the same. Thus, wages for income tax
withholding purposes are not always the same as wages for FICA and FUTA
purposes.
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\1\ Sections 3121(a) and 3306(b) were amended by section
327(b)(1) and (c)(4), respectively, of the Social Security
Amendments of 1983, Public Law 98-21, 97 Stat. 65 (1983).
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D. Application of Law to Statutory Stock Options
Revenue Ruling 71-52 (1971-1 C.B. 278) which was published before
the statutory changes to sections 3121(a) and 3306(b) mentioned
immediately above, addressed the FICA, FUTA, and income tax withholding
consequences applicable to the exercise of qualified stock options
under former section 422.\2\ The ruling holds that a taxpayer does not
make a payment of wages for purposes of FICA, FUTA, and income tax
withholding at the time of the exercise of a qualified stock option
under former section 422.
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\2\ Section 603 of the Tax Reform Act of 1976, Public Law 94-
355, 90 Stat. 1520 (1976), amended former section 422 to provide,
generally, that qualified stock options could not be granted after
May 20, 1976. Current section 422 (Incentive Stock Options) was
added to the Internal Revenue Code of 1954 (Code), as section 422A,
by section 251(a) of the Economic Recovery Tax Act of 1981, Public
Law 97-34, 95 Stat. 172 (1981). Subsequently, section
11801(c)(9)(A)(i) of the Omnibus Budget Reconciliation Act of 1990,
Public Law 101-508, 104 Stat. 1388 (1990), repealed former section
422 (Qualified Stock Options) and re-designated former Code section
422A as section 422 of the Internal Revenue Code of 1986.
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Notice 87-49 (1987-2 C.B. 355) addressed potential inconsistencies
among and coordination of the proposed regulations under former section
422A (current section 422), section 83, and Rev. Rul. 71-52. Notice 87-
49 provided that Rev. Rul. 71-52 was being reconsidered, but, until the
results of such reconsideration were announced, the principles of Rev.
Rul. 71-52 apply to the disposition of stock, acquired by an individual
pursuant to the exercise of an incentive stock option, which does not
meet the requirements of former section 422A(a) (current section
422(a)).
Notice 2001-14 (2001-6 I.R.B. 416) addresses the FICA, FUTA, and
income tax withholding consequences applicable to the exercise of
statutory stock options. Notice 2001-14 provides that in the case of
any statutory stock option exercised before January 1, 2003, the IRS
will not assess FICA or FUTA tax upon the exercise of the option and
will not treat the disposition of stock acquired by an employee
pursuant to the exercise of the option as subject to income tax
withholding. Notice 2001-14 also provides that Revenue Ruling 71-52 is
obsolete and that the holding of Revenue Ruling 71-52 does not apply to
the exercise of a statutory stock option or to the disposition of stock
acquired pursuant to the exercise of a statutory stock option.
Consistent with that conclusion, Notice 2001-14 also provides that the
provisions of Notice 87-49 described above no longer apply.
It has long been recognized that the transfer of stock to an
employee pursuant to the exercise of a nonstatutory stock option
granted in connection with employment constitutes a payment of
compensation to the extent that the fair market value of the stock
received by the employee pursuant to the exercise of the nonstatutory
option exceeds the option exercise price. Commissioner v. LoBue, 351
U.S. 243 (1956); Commissioner v. Smith, 324 U.S. 177 (1945). The
exclusion from gross income for income tax purposes that is provided by
section 421(a)(1) for the transfer of stock upon the exercise of a
statutory stock option, does not alter the compensatory character of
such stock transfers or serve to distinguish statutory stock options
from nonstatutory stock options for purposes of sections 3121(a) and
3306(b).
Comments Received Pursuant to Notice 2001-14
Notice 2001-14 announced the intent to issue further administrative
guidance clarifying current law with respect to the application of
employment taxes to statutory stock options and solicited public
comments on the anticipated guidance. In response to the request for
comments, the IRS received a number of comments addressing a variety of
topics pertaining to the application of FICA, FUTA, and income tax
withholding to
[[Page 57026]]
transactions involving statutory stock options. Because the proposed
regulations address only the application of the FICA, FUTA, and income
tax withholding at the time of exercise of a statutory stock option,
only comments relating to these types of transactions are addressed.
The IRS also received comments regarding an employer's income tax
withholding and reporting obligations upon the sale or disposition of
stock acquired by an individual pursuant to the exercise of a statutory
stock option. The IRS intends to publish two notices, discussed more
fully below, at the time of publication of these proposed regulations.
One notice includes proposed rules addressing an employer's income tax
withholding and reporting obligations upon the sale or disposition of
stock acquired by an individual pursuant to the exercise of a statutory
stock option. That notice discusses the comments received in response
to Notice 2001-14 relating to those types of transactions.
Most commentators who addressed the application of FICA and FUTA
tax at the time of exercise of a statutory stock option argued that
there was no statutory basis for such application. As discussed more
fully previously, the applicable Code provisions do not provide an
exception from FICA or FUTA tax for wages paid to an employee arising
from the exercise of a statutory stock option.
Several comments were received requesting that the IRS's
acquiescence on decision in Sun Microsystems v. Commissioner, T.C.M.
1995-69, acq. 1997-2 C.B. 1, not be affected by the proposed
regulations. The proposed regulations address only the application of
FICA and FUTA to statutory stock options and do not address the section
41 issues raised in the Sun Microsystems decision.
Some commentators also expressed concern about the administrative
burden of applying FICA and FUTA tax at the time of exercise,
especially as to former employees, because there is often no payment of
cash compensation to the employee at that time. As a result, some
employees may need to sell some shares of the acquired stock to fund
the employment tax obligations, resulting in a disqualifying
disposition of the shares sold. In addition, some commentators
expressed concern that the administrative burdens stemming from the
application of FICA and FUTA tax upon the exercise of statutory stock
options would make the use of these options less attractive to
employers and employees. However, commentators did not cite applicable
Code provisions that provide a statutory basis for excluding this type
of compensation from the relevant employment taxes. As discussed below,
the proposed regulations would enable the IRS to issue rules of
administrative convenience to lessen the administrative burdens that
commentators cited.
Explanation of Provisions
These proposed regulations would clarify current law regarding FICA
tax, FUTA tax, and income tax withholding on the transfer of stock
pursuant to the exercise of statutory stock options. These proposed
regulations would provide that at the time of the exercise of a
statutory stock option, the individual who was granted the statutory
stock option receives wages for FICA and FUTA purposes. These proposed
regulations would also provide that the amount of wages received equals
the excess of the fair market value of the stock acquired pursuant to
the exercise of the statutory stock option over the amount paid for the
stock.
The position taken in these regulations is based upon the broad
statutory definition of wages for FICA and FUTA purposes and the
absence of any statutory exclusion for this form of remuneration. These
regulations follow the Congressional directive that no exception from
FICA taxes should be created without a specific exclusion and the
section 3121(a) and 3306(b) provisions that no exception from FICA and
FUTA taxes should be inferred from the fact that income tax withholding
does not apply.
These proposed regulations would also provide that income tax
withholding is not required when an individual exercises a statutory
stock option because no income is recognized at the time of the
exercise by reason of section 421(a)(1).
In response to the concerns about administrative burdens, the
proposed regulations authorize the IRS to adopt rules of administrative
convenience to assist employers and employees in meeting the employment
tax obligations. Specifically, the proposed regulations permit the IRS
to adopt rules permitting employers to deem the payment of wages
resulting from the exercise of a statutory stock option as occurring at
a specific date or dates, including over a period of dates, as well as
any other appropriate rules of administrative convenience.
Section 424(h) provides that for purposes of the rules governing
incentive stock option plans and employee stock purchase plans, if the
terms of any option to purchase stock are modified, extended, or
renewed, such modification, extension, or renewal is considered as the
grant of a new option. Section 424(h)(3) generally defines the term
modification as any change in the terms of the option which gives the
employee additional benefits. The proposed regulations clarify that the
adoption of any of the rules of administrative convenience that may be
prescribed by the IRS pursuant to the proposed regulations, and the
application of those rules to outstanding incentive stock options under
section 422 or outstanding options under an employee stock purchase
plan under section 423, will not constitute a modification for purposes
of section 424(h).
These regulations are proposed to apply only upon publication of
final regulations in the Federal Register and cannot be relied upon
prior to publication. These proposed regulations, upon becoming final,
would be effective only for the exercise of a statutory stock option
that occurs on or after January 1, 2003. If these regulations are
finalized as proposed, neither FICA nor FUTA tax will apply to the
exercise of a statutory stock option prior to January 1, 2003.
Consistent with this proposed position, the IRS will not assert FICA or
FUTA tax which is based upon the exercise of a statutory stock option
that occurs prior to January 1, 2003.
While neither FICA nor FUTA tax will apply to the exercise of a
statutory stock option prior to January 1, 2003 if these regulations
are finalized as proposed, an employer will be able to apply the final
regulations to the exercise of a statutory stock option that occurs
prior to January 1, 2003 if the employer elects to do so.
Related Administrative Guidance
As noted above, the IRS is concurrently publishing two notices. One
of the two notices sets forth proposed rules of administrative
convenience under the authority provided to the IRS in the proposed
regulations. These proposed rules would permit employers to deem the
payment of wages resulting from the exercise of a statutory stock
option as occurring at a specific date or dates, including over a
period of dates. The notice also describes certain arrangements
available under the current federal tax law that may assist employers
and employees, including employee pre-funding of the employee portion
of FICA tax and employer advances of funds to satisfy the employee
portion of FICA tax.
[[Page 57027]]
The IRS is publishing a second notice that proposes rules regarding
an employer's income tax withholding and reporting obligations upon the
sale or disposition of stock acquired by an individual pursuant to the
exercise of a statutory stock option. As indicated above, the proposed
rule in this notice would state that the employer has no income tax
withholding obligation when an employee sells or disposes of stock
acquired by the employee pursuant to the exercise of a statutory stock
option.\3\
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\3\ These proposed regulations, along with the two notices, are
intended to clarify the application of employment taxes to statutory
stock options in a manner that recognizes and addresses the
practical burdens that are imposed, including the imposition of
withholding when neither the employer nor any other person (other
than the employee) has control over a payment of remuneration, while
also ensuring that ``amounts exempt from income tax withholding
should not be exempt from FICA unless Congress provides an explicit
FICA tax exclusion.'' Social Security Amendments of 1983 at S. Rep.
No. 98-23, 42, 98th Cong., 1st Sess.
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Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and because
the regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. All comments will be available for public inspection and copying.
Treasury and the IRS specifically request comments on the clarity
of the proposed regulations, how they can be made easier to understand,
and the administerability of the rules in the proposed regulations. In
addition, the proposed regulations do not include special rules for
transactions in which an individual exercising a statutory stock option
receives stock subject to a restriction, such as a substantial risk of
forfeiture. Treasury and the IRS also specifically request comments as
to whether the proposed regulations should include such special rules,
including comments as to the prevalence of incentive stock option plans
or employee stock purchase plans that impose such terms on stock
received pursuant to the exercise of a statutory stock option.
A public hearing has been scheduled for March 7, 2002, beginning at
10 a.m. in the Auditorium of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601 (a) (3) apply to the hearing. Persons
who wish to present oral comments at the hearing must submit an outline
of the topics to be discussed and the time to be devoted to each topic
(signed original and eight (8) copies) by February 14, 2002. A period
of 10 minutes will be allotted to each person for making comments. An
agenda showing the scheduling of the speakers will be prepared after
the deadline for receiving outlines has passed. Copies of the agenda
will be available free of charge at the hearing.
Drafting Information
The principal author of these proposed regulations is Stephen
Tackney, Office of the Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 31
Employment taxes, Income taxes, Penalties, Pensions, Railroad
retirement, Reporting and recordkeeping requirements, Social security,
Unemployment compensation.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 31 are proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.425-1, as proposed at 49 FR 4519 (February 7,
1984), is amended by adding a sentence immediately after the third
sentence of paragraph (e)(5)(i) to read as follows:
Sec. 1.425-1 Definitions and special rules applicable to statutory
options.
* * * * *
(e) * * *
(5)(i) * * * In addition, the application to an outstanding option
of any of the methods for the payment or withholding of employment
taxes under sections 3101, 3111, or 3301 that may be prescribed under
Sec. 31.3121(a)-1(k)(2) or Sec. 31.3306(b)-1(l)(2) of this chapter is
not a modification. * * *
* * * * *
PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAXES AT THE
SOURCE
Par. 3. The authority citation for part 31 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 4. In Sec. 31.3121(a)-1, paragraph (k) is added to read as
follows:
Sec. 31.3121(a)-1 Wages.
* * * * *
(k) Statutory stock options--(1) When an individual receives
wages--(i) Statutory stock option defined. For purposes of this
section, a statutory stock option is an option that either satisfies
the requirements of section 422(b) or is granted under a plan that
satisfies the requirements of section 423(b).
(ii) Wages at exercise. If an individual is granted a statutory
stock option, the individual receives wages when stock is transferred
to the individual pursuant to the exercise of the option. The amount of
the wages received by the individual is equal to the excess of the fair
market value of the stock, determined at the time of exercise, over the
amount paid for the stock by the individual. The provisions of this
paragraph (k) are illustrated by the following example:
Example. (i) Individual X is granted an option under a plan that
satisfies the requirements of section 423(b). The option allows X to
acquire 50 shares of stock of X's employer, Y, at an exercise price
equal to 85% of the fair market value of the stock at the time the
option is granted. The fair market value of the Y stock at the time
the option is granted is $100 per share. X exercises the option
later when the fair
[[Page 57028]]
market value of the Y stock is $120 per share. Thus, at the time of
exercise, X acquires 50 shares of Y stock having a fair market value
of $120 per share for $85 per share.
(ii) In this Example, at the time of exercise, X has received
wages equal to the excess of the fair market value of the stock
($120 per share) over the amount paid for the stock ($85 per share).
Thus, for purposes of section 3121, X has received wages equal to
$35 per share, for a total of $1,750.
(2) Rules of administrative convenience. The Commissioner may
prescribe rules of administrative convenience for employers and
employees to satisfy obligations under sections 3101 and 3111 that
arise with respect to wages received pursuant to the exercise of a
statutory stock option. Such rules may include, but are not limited to,
permitting employers to deem the payment of wages due to the exercise
of the statutory stock option as occurring at a specific date or dates,
including over a period of dates.
(3) Effective date. This paragraph (k) is applicable to the
exercise of a statutory option that occurs on or after January 1, 2003.
Par. 5. In Sec. 31.3306(b)-1, paragraph (l) is added to read as
follows:
Sec. 31.3306(b)-1 Wages.
* * * * *
(l) Statutory stock options--(1) When an individual receives
wages--(i) Statutory stock option defined. For purposes of this
section, a statutory stock option is an option that either satisfies
the requirements of section 422(b) or is granted under a plan that
satisfies the requirements of section 423(b).
(ii) Wages at exercise. If an individual is granted a statutory
stock option, the individual receives wages when stock is transferred
to the individual pursuant to the exercise of the option. The amount of
the wages received by the individual is equal to the excess of the fair
market value of the stock, determined at the time of exercise, over the
amount paid for the stock by the individual. The provisions of this
paragraph (l) are illustrated by the following example:
Example. (i) Individual X is granted an option under a plan that
satisfies the requirements of section 423(b). The option allows X to
acquire 50 shares of stock of X's employer, Y, at an exercise price
equal to 85% of the fair market value of the stock at the time the
option is granted. The fair market value of the Y stock at the time
the option is granted is $100 per share. X exercises the option
later when the fair market value of the Y stock is $120 per share.
Thus, at the time of exercise, X acquires 50 shares of Y stock
having a fair market value of $120 per share for $85 per share.
(ii) In this Example, at the time of exercise, X has received
wages equal to the excess of the fair market value of the stock
($120 per share) over the amount paid for the stock ($85 per share).
Thus, for purposes of section 3306, X has received wages equal to
$35 per share, for a total of $1,750.
(2) Rules of administrative convenience. The Commissioner may
prescribe rules of administrative convenience for employers to satisfy
obligations under section 3301 that arise with respect to wages
received pursuant to the exercise of a statutory stock option. Such
rules may include, but are not limited to, permitting employers to deem
the payment of wages due to the exercise of the statutory stock option
as occurring at a specific date or dates, including over a period of
dates.
(3) Effective date. This paragraph (l) is applicable to the
exercise of a statutory option that occurs on or after January 1, 2003.
Par. 6. In Sec. 31.3401(a)-1, paragraph (b)(15) is added to read as
follows:
Sec. 31.3401(a)-1 Wages.
* * * * *
(b) * * *
(15) Statutory stock options--(i) When stock is transferred
pursuant to an exercise--(A) Statutory stock option defined. For
purposes of this section, a statutory stock option is an option that
either satisfies the requirements of section 422(b) or is granted under
a plan that satisfies the requirements of section 423(b).
(B) Withholding at exercise. If an individual is granted a
statutory stock option, withholding is not required when stock is
transferred to the individual pursuant to the exercise of the option to
the extent that the individual does not recognize income by reason of
section 421(a)(1). The provisions of this paragraph (b)(15) are
illustrated by the following example:
Example. (i) Individual X is granted an option under a plan that
satisfies the requirements of section 423(b). The option allows X to
acquire 50 shares of stock of X's employer, Y, at an exercise price
equal to 85% of the fair market value of the stock at the time the
option is granted. The fair market value of the Y stock at the time
the option is granted is $100 per share. X exercises the option
later when the fair market value of the Y stock is $120 per share.
Thus, at the time of exercise, X acquires 50 shares of Y stock
having a fair market value of $120 per share for $85 per share. X
continues to hold the Y stock after exercise. Under section 421(a),
no income is recognized at the time of exercise.
(ii) In this Example, for purposes of section 3401, X has not
received wages at the time of exercise.
(ii) Effective date. This paragraph (b)(15) is applicable to the
exercise of a statutory stock option that occurs on or after January 1,
2003.
* * * * *
Robert E. Wenzel.
Deputy Commissioner of the Internal Revenue.
[FR Doc. 01-28535 Filed 11-13-01; 8:45 am]
BILLING CODE 4830-01-P