Stock Option Tax on Hold

IRS won't require collection of payroll tax on stock compensation plans...for now.
Lisa YoonJanuary 26, 2001

Companies plagued by the burden of collecting withholding tax on employee stock purchase plans (ESPPs) and incentive stock options (ISOs) will find some relief in a recent Internal Revenue Service announcement.

As a temporary solution to a controversial issue, the IRS announced a two-year moratorium last Thursday on its collection of payroll and withholding taxes on ESPPs and ISOs.

The announcement is the latest reversal on a matter that has caused uncertainty and dispute among companies for years. In the late 1960s, the IRS issued a revenue ruling indicating that employers were not required to impose withholding taxes on ESPPs and ISOs. But during some audits in the mid-1990s, the agency argued that companies needed to collect the payroll taxes on these plans. This inconsistency led to confusion and controversy among employers.

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“It’s great news for many companies,” says John Scott, director of retirement policy at the Washington, D.C.-based American Benefits Council. He adds that the move was long- awaited. “There’s been a lot of uncertainty on this issue for many years. In fact, there was an IRS announcement in 1987 that said they were studying the issue, and they had not followed up until now.”

The ruling lifts a significant administrative burden from companies, according to Paul Dorf, managing director of Compensation Resources Inc., an Upper Saddle River, N.J.-based compensation consulting firm. Although employees are responsible for eventually paying a capital gains tax when they sell upon appreciation of a stock, the onus was upon the company to collect those taxes from the employee. In the event that the company was unable to collect the money from the employee, the company had to pay the tax, or be subject to a fine from the IRS.

“[The IRS is] saying, ‘Look, forget about it, guys. People are still responsible for the tax, but we’re not going to hold the company responsible for it,’” says Dorf.

Melissa Cruz, CFO of Concord Communications, a Marlboro, Mass.-based E- business company, says the move will eliminate much of the administrative work involved in collecting withholding tax on ISOs. “It’s an awful lot of administration to keep track of. This will reduce our reporting requirements.”

The purpose of the unusually long two-year moratorium is to give the IRS some time to review the matter and decide on a permanent and decisive course of action. Dorf of Compensation Resources believes the non- collection policy will become permanent to incourage companies to use the plans. He says that if companies continue to experience confusion over how ISOs and ESPPs should be handled, they will ultimately discontinue them.

“The purpose of ISOs is to foster a sense of employee ownership, thereby enhancing productivity and ultimately adding value,” Dorf argues. “Collecting withholding taxes on such popular forms of compensation creates unnecessary complications to offering them.”