The Internal Revenue Service has proposed relief for rank-and-file employees who exercised backdated or otherwise mispriced stock options, provided their companies get with the program.

As it stands, notes the IRS, an employee who exercised properly priced options in 2006 would be liable simply for income tax on the difference in value between the grant date and the exercise date. But under a 2004 federal tax law governing deferred compensation, most employees who exercised mispriced options, even innocently, would also be liable for an additional 20 percent tax plus interest. The law does not affect options that were earned and vested before 2005.

The IRS initiative allows companies to step up and pay that additional liability for their employees, but not for top executives or other insiders “who were the principal beneficiaries of the backdating schemes.”

“This shameful practice was widespread,” said commissioner Mark W. Everson in a statement. “We are allowing employers to satisfy the tax obligations of employees who did not knowingly participate in these schemes.”

Employers must notify the IRS of their intent to participate in this initiative by February 28, and employers must inform affected employees by March 15. Companies that participate will be required to provide details of the options, including specifics on the tax calculation, so the IRS can ensure that the U.S. Treasury has received the full amount of taxes owed.

The 20 percent tax a company pays for an affected employee will be treated as additional compensation for that employee in the 2007 tax year, the IRS also stresses.

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