(This Item Posted April 2001)

Prepared By: Patricia K. Keesler

Benefits Law Group

Atlanta, Georgia

In January of this year, the IRS issued Notice 2001-14, relating to the application of FICA, FUTA and income tax withholding to statutory stock options. The notice provides that, in the case of any statutory option exercised before January 1, 2003, the IRS will not assess FICA tax or FUTA tax upon the exercise of a statutory option and will not treat the disposition the such stock acquired pursuant to such option, as subject to income tax withholding. Statutory options are incentive stock options (ISOs) described in Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code") and options granted under employee stock purchase plans described in Code section 423(b). The IRS also announced that Rev. Rul. 71-52 is now obsolete and does not apply to the exercise or disposition of statutory options. The IRS intends to issue further administrative guidance to clarify current law with respect to FICA tax and FUTA tax on the exercise of statutory options and to address the issue of whether the disposition of such stock is subject to income tax withholding.

In 1971, the IRS issued Revenue Ruling 71-52, which provided that a taxpayer did not have wages for FICA tax, FUTA tax and income tax withholding purposes at the time of the exercise of a qualified stock option under former Code section 422, or upon a disqualifying disposition of the stock. Rev. Rul. 71-52 was published before 1983 statutory changes to sections 3121(a) and 3306(b) and before there was no limit on the amount of wages for purposes of the Medicare portion of the FICA tax. In 1987, the IRS issued Notice 87-49 which provided that Rev. Rul. 71-52 was being reconsidered. Notice 2001-14 now provides that Rev. Rul. 71-52 is obsolete. Thus, with respect to the exercise of statutory options, the IRS will not require payment of FICA tax or FUTA tax. With respect to dispositions of stock acquired pursuant to the exercise of statutory options, the IRS will not require income tax withholding. However, the IRS reminds taxpayers that the individual will still need to include any compensation in income upon a disposition of stock acquired pursuant to the exercise of a statutory option, and employers must still report such amounts. Treasury and the IRS plan to issue more guidance with respect to FICA tax, FUTA tax, and income tax withholding on statutory options. The IRS has indicted that the administrative guidance could reflect the view that the statute defines ''wages'' for FICA tax and FUTA tax purposes broadly, without any statutory exclusion for exercises of statutory options. It is not anticipated, however that disposition of such stock will be subject to income tax withholding. Any new guidance would apparently be effective only prospectively.