Notice 2001-14

I. Purpose and Overview

This notice is intended to clarify the application of FICA, FUTA and income tax withholding to statutory stock options. With respect to incentive stock options (ISOs) described in section 422(b) and options granted under an employee stock purchase plan (ESPP) described in section 423(b) (collectively, “statutory options”), the notice

• provides that, in the case of any statutory option exercised before January 1, 2003, the Service will not assess FICA tax or FUTA tax upon the exercise of the option and will not treat the disposition of stock acquired by an employee pursuant to the exercise of the option as subject to income tax withholding;

• concludes that Rev. Rul. 71-52 is obsolete and that the holding of Rev. Rul. 71-52 does not apply to the exercise of statutory options or to the dis

(1) Application by April 30, 2001

(unless a sufficient number of applicants have been accepted to conduct the pilot sooner); (2) Taxpayer under Coordinated Examination by LMSB and also in Appeals; (3) LMSB examination years are sub stantially complete; and (4) The Appeals years will not be set tled before the first issue resolution conference is held.

mal exercise of its appeal rights for the years under examination by LMSB. Therefore, conferences between the taxpayer and the IRS CCR team will follow existing Appeals procedures. If the IRS and taxpayer reach agreement, years will be closed using Appeals processes and closing documents. If the parties are unable to reach agreement on any issue(s), Appeals will issue a statutory notice of deficiency on the unagreed issue(s). Should any case be subject to review by U.S. Competent Authority or the Joint Committee on Taxation, the case will be closed after those approvals are obtained.

7. WITHDRAWAL FROM THE COMPREHENSIVE CASE RESOLUTION PROCESS

Taxpayers may withdraw from the pilot program by submitting a written request, but only within 30 days after acceptance into the program or 20 days after the initial planning meeting, whichever is later. Thereafter, with respect to the years under LMSB jurisdiction at the time of application for the pilot program, the process will be completed with a total or partial agreement or issuance of a statutory notice of deficiency.

A taxpayer’s withdrawal from the pilot program returns each open year to the jurisdiction of the IRS function it was under prior to acceptance into the pilot program.

Taxpayers will be afforded administrative appeal on the years under LMSB jurisdiction as if the taxpayer had not applied for the pilot program.

8. MISCELLANEOUS

Record keeping requirements. No aspect of the CCR process will affect the record keeping requirements imposed by any section of the Internal Revenue Code. No user fee. There is no user fee for participating in the pilot program.

9. COMMENTS

The IRS invites interested persons to comment on this program. Send submissions to:

Internal Revenue Service Attn: Cary Russ Large and Mid-Size Business Division LM:PFTG Mint Building, 3rd Floor, M-3312

Additional pilot program criteria:

(1) Having a cross-section of taxpay ers of varying sizes, representing different industry lines, a geographical dispersion of cases, and a variety of issues; (2) IRS resource availability in LMSB,

Appeals and Chief Counsel; (3) The likelihood of the case being

resolved through this process; and (4) In the case of a docketed year, the

ability to comply with the Tax Court’s procedures and deadlines. Communication with taxpayer. The CCR Pilot Executive will advise taxpayers in writing whether they will be included in the pilot program. A taxpayer may not appeal the decision that it not be included in the pilot program.

6. CONDUCTING THE COMPREHENSIVE CASE RESOLUTION PROCESS

Initial 60 days. Once a case is accepted into the pilot program, the IRS will form a resolution team composed of members from LMSB and Appeals (and Chief Counsel, if there is a docketed case). Within the first 30 days, the CCR team will contact the taxpayer to schedule an initial planning meeting. At the planning meeting, the parties will confirm the issues to be resolved, identify who will be involved in the process and their respective authorities, answer any questions about the process, and establish a timeline for resolution of all issues. Additionally, the team and the taxpayer will schedule the first issue resolution conference no later that 60 days after the case is accepted into the pilot program. Resolution process. Comprehensive Case Resolution constitutes the taxpayer’s for

February 5, 2001 516 2001–6 I.R.B.

position of stock acquired pursuant to the exercise of statutory options; and

• announces the intent to issue further administrative guidance to clarify current law with respect to FICA tax and FUTA tax on statutory options and to address the issue of whether the disposition of stock acquired by an employee pursuant to the exercise of a statutory option will be subject to income tax withholding. This notice invites public comment on this anticipated guidance.

II. Background

A. Income Tax Withholding and

Reporting on Options

Income tax withholding is imposed under section 3402(a) of the Internal Revenue Code of 1986 (Code), which requires employers paying wages to deduct and withhold income tax on those wages. For income tax withholding purposes, section 3401(a) provides that the term “wages,” with certain exceptions, means all remuneration for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash.

The legislative history of sections 3401 through 3404 indicates that a purpose of income tax withholding is to enable individuals to pay income tax in the year in which the income is earned. H.R. Conf. Rep. No. 510, 78 ^th Cong., 1 ^st Sess., at 1 (1943); H.R. Rep. No. 401, 78 ^th Cong., 1 ^st

Sess., at 1 (1943); S. Rep. No. 221, 78 ^th

Cong., 1 ^st Sess., at 1 (1943). Income tax withholding generally is imposed upon remuneration paid by an employer only to the extent that an employee has income.

Under section 421, no compensation income results when a statutory option is exercised. Section 421(a) provides that, if a share of stock is transferred to an individual in a transfer that meets the requirements of section 422(a) or 423(a), no income results at the time of the transfer. Instead, compensation income is deferred until the sale or other disposition of the stock acquired pursuant to the exercise of a statutory option.

Employers making wage payments to an employee (or former employee) that are subject to income tax withholding generally must report such wage pay

ments on Form W-2, as provided in section 31.6051-1(a)(1) of the Employment Tax Regulations. Under certain circumstances, a payment made by an employer to an employee (or former employee) must be reported on Form W-2 even if the payment is not subject to income tax withholding. Specifically, section 1.60412(a)(1) of the Income Tax Regulations generally requires reporting if the total amount of the payment and any other payments of remuneration (including wages, if any) made to the employee (or former employee) that are required to be reported on Form W-2 aggregate at least $600 in a calendar year.

B. FICA and FUTA Tax

Under sections 3111 and 3301, Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax, respectively, are imposed on the employer in an amount equal to a percentage of the wages paid by that employer. Under section 3101, FICA tax also is imposed on the employee. Under sections 3121(a) and 3306(b), the term “wages” for FICA tax purposes and FUTA tax purposes, respectively, means, with certain exceptions, all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. Neither the Code nor the relevant regulations contain any provision excluding the value of stock transferred pursuant to the exercise of a statutory option from wages for FICA tax and FUTA tax purposes.

In 1981, the Supreme Court in Rowan Companies, Inc. v. U.S., 452 U.S. 247, held essentially that the definition of “wages” for FICA tax and income tax withholding purposes was the same. As part of the Social Security Amendments of 1983, Pub. L. No. 98-21, 97 Stat. 65, Congress reversed this holding. Sections 3121(a) and 3306(b) ¹ were amended to provide that “[n]othing in the regulations prescribed for purposes of chapter 24 (relating to income tax withholding) which provides an exclusion from ‘wages’ as used in such chapter shall be construed to require a similar exclusion from ‘wages’ in the regulations prescribed for purposes of this chapter.” This sentence makes clear that the definition of wages for income tax withholding purposes is not always the same as the definition

of wages for FICA tax and FUTA tax purposes, and that an item of income can be wages for FICA tax purposes even if it is not wages for income tax withholding purposes.

The legislative history of the 1983 provision explains that Congress intended to reverse the holding in Rowan, and the Senate Report states: “Since the [social] security system has objectives which are significantly different from the objective underlying the income tax withholding rules, the committee believes that amounts exempt from income tax withholding should not be exempt from FICA unless Congress provides an explicit FICA tax exclusion.” S. Rep. No. 23, 98 ^th

Cong., 1 ^st Sess., at 42 (1983).

C. Administrative Guidance

Revenue Ruling 71-52 (1971-1 C.B. 278) addressed the FICA tax, FUTA tax and income tax withholding consequences applicable to the exercise of qualified stock options under former section 422 ² . The ruling holds that a taxpayer does not make a payment of wages for FICA tax, FUTA tax and income tax withholding purposes at the time of the exercise of a qualified stock option under former section 422, and that income realized by employees and former employees from a disqualifying disposition of stock acquired by the exercise of a qualified stock option is also not wages for FICA tax, FUTA tax and income tax withholding purposes.