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May 16, 2002
IRS Draws Fire Over Plan to Tax Options
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or corporations, including Marriott International and Texas Instruments Inc., are pressing the Internal Revenue Service to kill or delay a plan to impose payroll taxes on incentive stock options and employee stock purchase plans.

Adopting the IRS plan would make the benefits so costly, they warn, that many firms would have to drop them, regardless of their popularity.

The Boston Globe reports that corporate executives testified at a special IRS on Tuesday, complaining that the plan would be a nightmare to administer and would unfairly penalize workers. They also spoke of multiple lawsuits, questioning whether the government had the legal authority to alter 30 years of policy regarding the plans.

"Reversing course and changing the ground rules now will unjustly force many employers into rethinking benefit policies," testified Gregory Sikon, vice president for global tax planning at CIENA Corp.

"Instead of encouraging employer use of equity benefit plans, the likely result is that many employers will eliminate their use altogether," said Sikon, who spoke on behalf of the American Electronics Association.

The debate centers on an IRS plan to levy Social Security and Medicare taxes of about 15.3 percent on certain types of stock options when they are exercised. The IRS expects the change, scheduled to take effect on Jan. 1, 2003, to raise more than $23 billion over the next decade.

The IRS has maintained that federal law broadly defining wages subject to payroll tax gives them ample authority, and responsibility, to act. The number and size of stock option plans have increased dramatically since a 1971 ruling on the subject.

According to the Globe, the IRS proposal would affect two types of stock plans that receive special treatment under the federal tax code - incentive stock options and employee stock purchase plans.

Under incentive plans, employees have the option to buy stock at a set point at a specified price. Workers who comply with requirements, including holding the stock for a certain time, would pay the capital gains rate when the stock is sold. Under employee stock purchase plans, workers are allowed to buy stock at a discount, usually 15 percent. Many of the same general tax principles apply.

Many companies use the incentive stock option plans to reward executives, though opponents of the IRS rule say they are increasingly being offered to rank-and-file workers.

The rules would change current tax treatment by imposing payroll taxes on the difference between the fair market value and the price paid for the stock at the time an option is exercised. The payroll taxes include a 2.9 percent Medicare levy and a 12.4 percent Social Security tax, split between employers and employees. The Social Security tax is now levied on the first $84,900 in earnings, but there are no limits on the Medicare tax.

To read the Boston Globe article, click here.
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