Taxing Employee Stock Option Programs.

• Author: Hinchman, Grace
• Position: Washington Insights - Brief Article

It seems as if stock options have become the punching bag for public policy-makers. Six years ago, stock option accounting triggered one of the most divisive battles ever waged before the Financial Accounting Standards Board (FASB). Now the International Accounting Standards Board (IASB) is considering how to account for share-based compensation plans.

The IASB's decision to take on this highly contentious issue has already outraged multinational corporations and U.S. policy-makers to the point that it could seriously damage the IASB's credibility. In addition, Nasdaq and the New York Stock Exchange are both considering proposals to require shareholder approval of stock option plans offered by their listed companies.

Now, to make matters worse, the U.S. Internal Revenue Service has jumped onto the stock option bandwagon. In January 2001, the IRS published a notice (IRS Notice 200173) saying that stock options exercised before Jan. 1, 2003 would not be subject to payroll taxes.

However, after that date, employees will be taxed when they exercise their stock options, thus creating a payroll tax liability. The net effect of this announcement would be to reverse a 30-year tax policy of not subjecting incentive stock options (ISOs) and employee stock purchase plans (ESPPs) to payroll tax withholdings.

Legislation has been introduced in both the House of Representatives and the Senate to stop the IRS from going forward with its intention to subject ISOs and ESPPs to payroll taxes. The bills, H.R. 2695 and 5. 1383, were sponsored by Rep. Amo Houghton (R-N.Y.) and Sen. Hillary Clinton (D-NY). Both bills are currently pending before the House Ways and Means Committee and the Senate Finance Committee, but the likelihood of their passage is uncertain.

Congress originally created these stock benefits to encourage broad-based employee stock ownership, an action that has been regarded as contributing to long-term growth in the U.S. economy. Because of the long-held...