On June 9, , the Institute submitted the following comments to the Department of the Treasury and Internal Revenue Service requesting updated guidance on the rules governing employment and withholding tax deposits relating to the exercise of nonqualified stock options. The comments, which took the form of a letter from TEI President J.A. (Drew) Glennie, were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Mitchell S. Trager of Georgia-Pacific Corporation. Contributing substantially to the development of TEI's comments were Michael S. Nesbitt of Paychex, Inc., chair of TEI's Subcommittee on Benefits and Payroll Taxes, and Neil D. Traubenberg of Storage Technology Corporation.
In related action, TEI President Drew Glennie submitted a letter to the Commissioner of the Large and Mid-Size Business Division, Deborah M. Nolan, commending LMSB for issuing the Field Directive of March 14, , limiting the application of the penalty for failure to timely deposit withholding taxes on the exercise of nonqualified stock options. The two-page letter can be obtained by contacting TEI Washington.
On behalf of Tax Executives Institute, Inc., I am writing to request the issuance of guidance clarifying when income tax withholding and employment tax deposits are due following the exercise of nonqualified stock options (NQSOs). During liaison meetings with the IRS Large and Mid-Size Business (LMSB) Division and the Treasury Department, TEI noted that IRS examiners were asserting or threatening assertion of penalties against employers for failing to timely deposit employment and income tax liabilities where such amounts exceeded $100,000 and were not deposited by the day after the exercise of the NQSOs. TEI said that there is a lack of clear guidance in respect of the date wages are considered paid upon the exercise of NQSOs, engendering confusion for taxpayers. In the absence of clear guidance, it would be inequitable for the IRS to assert the penalties. As important, it would be burdensome for employers to timely comply with a stringent interpretation of the "next-day" deposit rule--especially those subject to the semiweekly deposit schedule--upon exercise of NQSOs. The LMSB and Treasury Department representatives invited TEI to submit comments elaborating on its concerns and recommendations, especially in respect of whether rules of administrative convenience would enhance compliance.
Subsequently, in a Field Directive dated March 14, , IRS examiners were instructed, solely for penalty purposes, not to challenge the timeliness of employment and withholding tax deposits exceeding $100,000 that arise from the exercise of the stock options, as long as the deposits are made within one day of the settlement date of the option. TEI commends LMSB for issuing the Field Directive, but we believe that more up-to-date guidance and more administrable rules governing the timing of tax deposits in respect of the exercise of NQSOs should be provided to employers. Since most NQSO plans are administered through stock brokers and the cash for the exercise price and employment and withholding taxes is not available to the employer on the date of exercise, we urge the IRS and Treasury Department to issue rules of administrative convenience for FICA, FUTA, and income tax withholding related to NQSO exercises that are similar to those set forth in Notice -73. We suggest that employers be permitted to make the requisite tax deposits within a reasonable period of time following an NQSO's settlement date. A reasonable period of time for making the deposit following the employer's receipt of notice from the broker that an option has been exercised would, at a minimum, be no earlier than the deposit date for the employer's next regularly scheduled payroll processing period for "cash" wages. TEI is pleased to provide the following comments and elaborate on our recommendations.
Tax Executives Institute
Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,300 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply.
Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises, including the employment and withholding tax deposit rules applicable to compensation. In addition, since most members' companies grant nonqualified stock options to their employees, members must advise their companies on the associated employment and withholding tax liabilities that arise from the exercise of NQSOs. The diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to these issues.
Overview of Current Rules and TEI's Recommendation
Upon exercise of a nonqualified stock option (NQSO), an employee receives income from wages that is subject to withholding for federal income, social security (Federal Insurance Contribution Act or FICA) taxes, and Medicare taxes, as well as for state and local income taxes. Correspondingly, the employer is obligated to pay its share of applicable FICA and Medicare (and possibly Federal Unemployment Tax Act or FUTA) taxes for the wage income. TEI does not question whether the taxes are owed by either the employer or the employee. Rather, the questions are when the employment and withholding tax deposits should be made in order to be considered timely and whether the deposit rules are administrable. To be administrable, the rules governing the timing of the tax deposits must afford employers sufficient time to accumulate and process the requisite information and make timely deposits. Moreover, administrable rules should not impose undue burdens by compelling employers to process and update their payroll records every date an NQSO is exercised, which under the next-day deposit rule could be every day the stock market is open.
The IRS has issued one ruling that addresses the employment tax treatment of option exercises. (1) Rev. Rul. 67-257, however, predates the enactment of section 83 of the Code and arguably became obsolete upon the section's enactment. More important, although the ruling likely reflected common practice in 1967, it does not reflect current employer compensation policies and stock plan administrative practices. Specifically, most stock option plans today cover a much broader range of employees than was the case in 1967. In addition, the FICA and Medicare wage base have expanded substantially. Thus, many more employees are subject to FICA and Medicare taxes in addition to federal (and state) income tax withholding as a result of option exercises. Correspondingly, stock options are exercised far more frequently, potentially subjecting employers to multiple payroll processing requirements and more frequent employment tax deposits if the exercise of the NQSO were to trigger the next-day deposit rule.
The 1967 ruling is also factually inapposite because it rests on the premise that employees tender cash or a check in payment of the option price and related tax liabilities upon the exercise of the option. Today, many, if not most, employer stock option plans are broker-assisted, an administrative feature that permits employees to exercise their stock options without obtaining a loan to pay the option price and related tax liabilities. In view of the changes in employer compensation and stock plan administrative practices, we urge the IRS and Treasury Department to (1) issue updated employment and withholding tax deposit guidance for NQSO exercises, including a rule of administrative convenience to govern the timeliness of the deposits and (2) if necessary, provide a window during which employers, brokers, payroll service providers, and stock transfer agents can modify their procedures to comply with new guidance.
Description of NQSO Exercises
