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IRS announces reporting relief program for discounted employee stock options - employer action required by February 28

Yesterday, the IRS has announced a special program to reduce the reporting burdens for non-insider employees who exercised discounted stock options and stock appreciation rights during 2006. The employer will report and pay for the employees the special taxes relating to deferred compensation under Internal Revenue Code Section 409A. The payment will be taxable income for the employees in the year of payment. Employees will not separately compute and report the additional 20% tax plus interest tax with their 2006 individual income tax returns, but still will have to include the income in their taxable income.

The program only applies to amounts reportable for 2006.

The program only applies to employees and former employees who are not "insiders" subject to the disclosure requirements under section 16(a) of the Securities Exchange Act of 1934 or subject to those requirements when the stock right was granted.

A common reason for the stock rights to have a discounted price is backdating.

The employer must notify the IRS of its intent to participate in the program by February 28, 2007. The reason the notification is required so soon is employers are required to submit a copy of Form W-2 to the Social Security Administration by that date. The employer must also notify the affected employees within 15 days of providing the notice to the IRS.

Employers who participate in the program should not report the amount relating to employee stock options and stock appreciation rights subject to the special tax in box 12 of Form W-2 with a code Z. If they have already submitted the W-2 forms, corrected W-2s should be issued using Form W-2c, with those amounts in box 12 deleted.

The employer must then submit to the IRS by June 30, 2007 a list of the employees, lists of the disqualified stock rights exercised, and the amounts of the Section 409A taxes due for each of them, together with a payment for the taxes plus any penalties and interest due. If the payment is made after April 17, 2007, an amount must be paid for the penalty for late payment of tax plus interest.

The employer must provide a notice to the affected employees by July 15, 2007 certifying whether the employer has fulfilled the requirements of the program or not.

The payments by the employer on behalf of the employees is additional compensation, subject to income tax and employment tax withholding and to be reported on the employer's payroll tax returns and W-2 forms for the period within which the payments were made. This may require a "gross up" computation, as described in Revenue Ruling 58-113 and Revenue Procedure 81-48.

If the employer fails to comply with the requirements of the program, the relief from employee reporting will not apply and additional penalties and interest may result. If the employee relied on a notice from the employer and the employer didn't follow through with the requirements, the employee will have a reasonable cause for failure to comply. (Keep the notice.)

This is just an outline of the program. You can find the details in IRS Announcement 2007-18, 2007-9 IRB. You can get a copy at the IRS website, www.irs.gov/pub/irs-drop/a-07-18.pdf

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IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication 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.

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Consult with a tax advisor

For our readers who aren’t tax advisors, this newsletter is intended to alert you about tax issues that could affect you. It is not a substitute for advice from a professional tax advisor. You will find that getting advice from a qualified advisor is a worthwhile investment.

Tax advisors should view the newsletter as an alert to become aware of issues relating to employee stock options for further research and study.

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(Michael Gray is the co-author of Employee Stock Options – A Strategic Planning Guide for the 21st Century Optionaire. You can order the book at www.amazon.com or www.barnesandnoble.com or buy it at Stacey’s Books.)

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