Should a former employee’s NQSO exercises be reported on a 1099 or W-2?

March 28, 2003

Subject:   Help!
Date:   Tue, 25 Feb 2003
From:   Angie

Hello Mr. Gray:

I am a former employee at wit’s end. I exercised NQSO options after leaving my employer in 2001. I exercised in 2002 and was issued a 1099; my tax person tells me it should have been a W-2 making the employer liable for some taxes.

My employer says because I wasn’t an employee at the time of the exercise in 2002 they are right with the 1099.

Who is right? Help!



Date:   Mon, 24 Mar 2003

Hello Angie,

This is a difficult issue that has confused me, too. I think your tax person is right. Here’s the authority for my conclusion.

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.)

Try giving this information to your former employer and have them discuss it with their accountants. Let me know if they disagree and why.

Good luck!

Mike Gray

[FOLLOW UP NOTE: Angie did give this information to her former employer, and their tax attorneys agreed with Michael Gray’s interpretation.]

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