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IRS Withdraws Proposed Regulations Dealing with Payroll Taxes on Statutory Options

Esther A. Streete


The Service withdrew proposed regulations dealing with the application of the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and the collection of Income Tax on stock based compensation, specifically, Incentive Stock Options (ISOs) and Employee Stock Purchase Plan (ESPP).

The withdrawal was done to reflect changes to the Code made in the 2004 American Jobs Creation Act (the Act). Under the proposed regulations, the exercise of a statutory stock option would have resulted in wages that were subject to FICA and FUTA taxes. However, the Act provides that the transfer of stock pursuant to the exercise of an ISO or under an ESPP after October 22, 2004, or any disposition of such stock are excluded from being treated as FICA and FUTA wages. The Act also amended the Code to provide that no income tax withholding is required on a "disqualifying disposition" of stock acquired as a result of the exercise of a statutory stock option or when compensation is recognized in connection with an ESPP discount.

The withdrawal of the proposed regulation makes the regulations congruent with the Code and clarifies the law. Together, the amendment of the Code and the withdrawal of the proposed regulations are favorable for executive compensation planning and provide great tax planning opportunities. Tax advice should be sought on how to structure compensation packages in order to take advantage of this change in the tax law.