SECTION 2. BACKGROUND

.01 Tax treatment of stock options . Section 83 of the Internal Revenue Code governs the tax treatment of nonstatutory stock options granted in connection with the performance of services. Sections 421 through 424 govern the tax treatment of statutory stock options, i.e., incentive stock options described in § 422(b) and options granted under an employee stock purchase plan described in § 423(b). A stock option is not taxable when granted, provided the option either lacks “a readily ascertainable fair market value” as defined in § 1.83–7(b) of the Income Tax

July 22, 2002 173 2002–29 I.R.B.

Section 1001 dictates the tax consequences when substantially vested stock obtained through the exercise of an option is sold. Pursuant to § 1001(a), the gain from sale of the stock is the amount realized minus the adjusted basis provided in § 1011, and the loss is the adjusted basis provided in § 1011 minus the amount realized. For this purpose, the adjusted basis of the stock includes the amount included in gross income under § 83(a) upon exercise of an option that did not have a readily ascertainable fair market value at grant.

.02 Information reporting - Form W–2 and Form 1099 . Section 6051 provides generally that an employer must annually report to each of its employees the total wages paid to the employee. Compensation income constitutes “wages” for purposes of this reporting obligation. Form W–2 is used to report the information required by § 6051.

Section 6041 provides that where a person engaged in a trade or business makes payments in the course of the trade or business to another person of compensation of $600 or more in a taxable year, the person must render a return, in accordance with such regulations as the Secretary may prescribe, that sets forth the amount of the income, and the name and address of the recipient of the payment. Forms in the 1099 series are generally used to report the information required by § 6041 where the compensation income does not constitute wages, such as where the service provider does not provide the services as an employee of the service recipient.

.03 Information reporting - Form 1099–B . Section 6045(a) provides that brokers, when required to do so by the Secretary, must make a return in accordance with such regulations as the Secretary may prescribe regarding transactions they carry out for customers.

Section 1.6045–1(c)(2) of the regulations states, in general, that each broker must make a return of information with respect to each sale by a customer effected by the broker.

Section 1.6045–1(d)(2) provides, in part, that a broker must report the gross proceeds of a stock sale.

Section 1.6045–1(d)(5) provides that the broker may, but is not required to, take commissions and option premiums

into account in determining gross proceeds provided the treatment chosen is consistent with the books of the broker. Form 1099–B is used to report the information required by § 6045 and the regulations thereunder.

Section 1.6045–1(c)(3)(ii) states that no return of information is required with respect to a sale effected by a broker for a customer if the sale is an excepted sale. This regulation defines an “excepted sale” as one so designated by the Internal Revenue Service in a revenue ruling or revenue procedure published in the Internal Revenue Bulletin.