FROM THE OFFICE OF PUBLIC AFFAIRS
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July 1, 2003JS-521
Purporting to Defer Taxes on Stock Option Gains
Today, the Treasury Department and the IRS issued regulations and a notice that will shut down arrangements involving stock options that are being promoted to executives as a method of deferring tax on gains from their stock options. Stock option gains are generally taxed at exercise. Promoters have devised arrangements intended to defer the tax on the option gains beyond the exercise date. In the regulations and the notice, Treasury and the IRS stated that use of the arrangements does not defer tax.
The arrangement involves an executive transferring stock options to a related party, such as a family member or a family limited partnership in which the executive or the executive’s family has a substantial interest. In exchange, the executive receives a long-term unsecured note. The related party exercises the option and claims that it does not recognize gain until the stock is sold, and then only if the sale price exceeds the amount paid for the option plus the exercise price. Promoters of this transaction claim that the executive does not have to pay tax until payments are made on the note, even though the executive retains control over the exercise of the options through the family member or family limited partnership.
The notice states that the IRS will challenge the executive’s claim that income from the exercise of the stock options can be deferred. The regulations, which are effective immediately, prevent an executive or any other person from claiming tax deferral from the transfer of options to a related party.
“The notice and the regulations eliminate any question that the arrangements can be used to defer stock option gains,” stated Treasury Assistant Secretary for Tax Policy Pamela Olson. “Executives cannot defer income taxes on stock option exercise by purporting to sell their stock options to a family member or family limited partnership.”
This transaction, and any transaction that is substantially similar, are identified as “listed transactions” that are subject to disclosure by both the executive and the related person, and to list-keeping and registration requirements. Neither the notice nor the regulations affect transactions between the executive and the company that issued the options.
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