IRS to aggressively pursue executive stock option scheme participants.

• Author: Takacs, Natalie Bell

In the late 1990s and early 2000s, professional service firms and financial institutions aggressively promoted an abusive tax avoidance transaction--the "executive stock option scheme." Executives (often facilitated by their corporate employers) transferred stock options to fanny limited partnerships (FLPs) and other related entities typically created for the sole purpose of receiving the options and avoiding taxes on compensation income normally taxed to the executive. The objective was to defer (for up to 30 years) taxes on the compensation; in many cases this resulted in the corporation deferring a legitimate deduction for the same compensation. In 2003, the IRS pinpointed this scheme in Notice 2003-47 as a listed transaction. To date, it has identified unreported income of more than $700 million, related to participation in transactions that are virtually the same as that described in the notice or similar to it.

In Ann. 2005-19, the Service introduced a settlement initiative aimed at encouraging executives and corporations to disclose their participation in listed transactions voluntarily. It is available for a stock option transfer made from an executive to a related person before July 2, 2003. Taxpayers involved in a court proceeding to determine the tax treatment of a transaction cannot participate.

Settlement Initiation

Although Ann. 2005-19 encouraged executives, FLPs and corporations to take part in the settlement initiative, executives (along with FLPs) could participate regardless of the corporation's participation, and vice versa. To notify the Service of their intent to participate in the settlement initiative, executives were required to submit Form 13656, Notice of Election by Executive and Related Person, to the IRS before May 24, 2005; corporations were required to submit Form 13657, Notice of Election by Corporation to Participate in Announcement 2005-19 Settlement Initiative. The Service will not extend the deadline.

Information Required

Under the elections, the parties had to disclose (under penalties of perjury) all details relevant to the transaction and to compute tax and penalties in accordance with Ann. 2005-19. In addition, corporations had to disclose the name, address and Social Security number of all their current and former officers, directors and employees that participated in the transaction. After the Service receives the necessary information, it will prepare a closing agreement under Sec. 7121 reflecting...