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Subject:   Nonqualified option-former employer
Date:   Tue, 13 May 2003
From:   Carol

Hi,

An individual was employed by a company from which he held nonqualified stock options. After terminating employment, the individual exercised some of the nonqualfied options and sold them on the same day. The former employer sent the individual a Form 1099-MISC for "non-employee compensation" for the difference between the fair market value of the stock and the price paid for the stock.

Is the individual subject to self-employment tax (i.e. both the employer and employee portions of the FICA/Medicare tax) for this compensation? Isn't the former employer responsible for the employer portion of social security and medicare taxes as these "wages" resulted from employment at the company?

The company will not revise to a W-2.

Thanks very much,

Carol

Answer

Date:   30 May 2003

Hello Carol,

This is a confusing area that I last answered in the March 11, 2002 issue of ESOAA Option Alert.

The IRS explanation for proposed regulations issued late in 2001 relating to withholding for ISOs and ESPPs point back to the definition of wages under the regulations.

For income tax withholding, under Treasury regulations section 31.3401(a)-1(a)(5), "Remuneration for services, unless such remuneration is specifically excepted by the 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."

A similar rule applies under Treasury Regulations Sections 31.3121(a)-1(i) and 31.3306(b)-1(i) for FICA withholding and FUTA taxes.

There is an exception when an option is exercised after the year of death of a deceased employee. (Revenue Ruling 86-109.)

I do not work extensively in the area of payroll tax reporting. Employers should be seeking their own counsel in this area.

Good luck!

Mike Gray

For more information about non-qualified stock options, request our free report, Non-Qualified Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.