IRS Gives Employers Breathing Room on Options Withholding

January 21, 2001 ( - In a surprising move, the Internal Revenue Service says it won't impose employment and income tax withholding on certain stock option transactions until 2003. The decision is good news for plan sponsors, spared of a potential administrative nightmare for the time being.

In recent months the IRS had been assessing tax deficiencies on companies for failing to withhold employment taxes on the exercise of ESPP options, as well as failing to withhold income taxes on disqualifying dispositions of statutory options.

Good News

The good news came in Notice 2001-14 , which says that certain option transactions will not be considered wages for purposes of applying FICA, Federal Unemployment Tax Act taxes, and income tax withholding. 

Excluded were:

  • incentive stock options described in Internal Revenue Code Section 422(b)
  • options granted under an employee stock purchase plan (ESPP) described in Section 423(b) that are exercised prior to Jan. 1, 2003.

The IRS notice also said Revenue Ruling 71-52 is obsolete, and does not apply to the exercise of statutory options or to the disposition of stock acquired pursuant to the exercise of stock options.

More Coming

However, the IRS did say that it plans to issue additional guidance to clarify its position on FICA and FUTA taxes on statutory options  – and to address the issue of whether the disposition of stock acquired by an employee pursuant to the exercise of options will be subject to income tax withholding.

The IRS is asking for comments by May 7.  The notice is scheduled to appear in Internal Revenue Bulletin 2001-6, dated Feb. 5.

Comments should reference Notice 2001-14, and be addressed to: Associate Chief Counsel (Tax Exempt and Government Entities)  CC:TEGE ATTN: Employment Taxes and Statutory Options, Room 5214, Internal Revenue Service, 1111 Constitution Ave., N.W. , Washington, D.C. 20224.