Employee benefits & pensions.

• Author: Cvach, Gary Q.
• Position: Current developments - Part 2

This two-part article provides an overview of current developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part II, below, focuses on general developments in executive compensation and health and welfare issues.

Part I, in the last issue, focused on general developments in retirement plan qualification requirements and employee stock ownership plans. Part II, below, addresses executive compensation and health and welfare benefit issues.

Executive Compensation

Optional Reporting of Stock Options

Ann. 2001-92 (19) has extended relief from mandatory separate reporting of compensation from employer nonqualified stock options (NQSOs) through 2002. According to the IRS, the use of Code V in Box 12 on 2002 Form W-2 is optional, but mandatory for 2003. The IRS is considering alternative cost-effective methods for collecting this information.

New Form 1099-B Reporting Exceptions

Rev. Proc. 2002-50 (20) provided an exception to reporting transactions involving an employee, former employee or other service provider who has obtained a stock option in connection with the performance of services, on Form 1099-B,"Proceeds From Broker and Barter Exchange Transactions." Under this exception, if the stock option exercise and the stock sale through a broker occur on the same day, the broker will not be required to report the sale on Form 1099-B, as long as the transaction meets certain requirements.

After exercise of the NQSOs, service providers (including employees and former employees) will often direct an immediate sale of some or all of the acquired stock for cash. In such a "cashless exercise" service providers can pay the exercise price and any employment taxes without having to use their own funds. These immediate exercise and sale transactions are typically handled by third-party administrators (such as brokerage firms and banks) through an agreement with the employer sponsoring the NQSO plan.

The service providers covered by the plan instruct the brokerage firm or bank as to how and when NQSO should be exercised. For income tax purposes, the optioned stock's sale price is the stock's fair market value (FMV) at excercise. Thus, service providers do not realize additional income on the sale of the optioned stock, because their tax basis in the NQSO stock equals the sales price.

Qualifying for exception. The exception will apply to a sale of stock acquired by a service provider via the exercise of an option if:

* The sale is executed for the service provider on the same day that stock being sold is acquired through exercise of an option;

* The option was granted in connection with the performance of services, such that the transaction's Federal tax consequences are governed by Sec. 83;

* The service recipient certifies in writing to the broker that he or she will report any compensation income generated by the (1) option's exercise or (2) disposition of the stock acquired via the exercise; and

* The broker either does not charge for the transaction or charges a fee and gives the service provider a written statement, as described in Rev. Proc. 2002-50, Section 4.03.

The exception will not apply if the stock option had a readily ascertainable FMV at the grant date, or the service recipient uses an amount other than the shares' sale price to calculate the compensation income generated to the service provider by the option exercise.

Additional Sec. 280G Guidance

Proposed Sec. 280G regulations (21) on golden parachute payments have been amended; Rev. Proc. 2002-45 (22) provides additional guidance on stock option valuation for Secs. 280G and 4999 purposes.

The most important change to the Sec. 280G proposed regulations is the change to their effective date. Under Prop. Regs. Sec. 1.280G-1, Q&A-48, taxpayers can rely on the rules for the treatment of any parachute payment. Thus, a taxpayer can rely on the proposed regulations for any parachute payment, not just a payment made after the Feb. 20, 2002 release date of the regulations. This gives taxpayers greater flexibility in determining whether to use the 1989 or the 2002 proposed regulations.

Another correction includes the addition of Sec. 132(m) qualified retirement planning services to the list of nondiscriminatory employee plans or programs defined in Regs. Sec. 1.280G-1, Q&A-26(c).

Valuing stock options. Rev. Proc. 2002-45 provides guidance on the proper valuation of stock options for both publicly and nonpublicly traded stock. A stock option for nonpublicly traded stock will be properly valued for Secs. 280G and 4999 purposes if the value is determined using any valuation method consistent with generally accepted accounting principles (GAAP) and considers the...