IRS Compliance Resolution Program for 409A Taxes on Discounted Options and Update Regarding NQDC Legislation

Employee Benefits Alert
02.16.07

Announcement 2007-18 (Section 409A Tax Compliance Resolution Program)

On February 8, 2007, the IRS released Announcement 2007-18 (the “Announcement”) which describes a new compliance resolution program that will allow employers to pay the additional taxes incurred by certain (non-insider) employees under section 409A upon the exercise of certain discounted stock options in 2006. However, this program requires action by February 28, 2007.

The program provides that an employer can pay the additional section 409A taxes, i.e., the 20% penalty tax and the accompanying interest tax, for those employees who exercised discounted stock options or stock appreciation rights subject to section 409A (including so-called “backdated” options or SARs) during 2006 and who are not now, nor were at the time of grant, Section 16(a) officers. According to the Announcement, the program is intended to minimize the burdens of employees who are not corporate insiders while insuring that all applicable taxes required by section 409A are paid.

Scope of Relief:

  • Employer can pay the additional section 409A taxes incurred by an eligible employee due to the exercise of noncompliant stock options or SARs in 2006. The employee will not be required to pay the additional section 409A taxes on his or her federal income tax return for the 2006 year with respect to the amounts attributable to the exercise of the noncompliant option or SAR (of course, this would not relieve the employee from reporting taxable income that would otherwise be incurred upon exercise).
  • Employer is not required to report the section 409A inclusion amount with respect to such stock options or SARs in box 12 of Form W-2 using Code Z (and the employer can correct a previously filed W-2 that included such designation).
  • The program is only open with respect to stock options or SARs that are subject to Section 409A because they were issued with an exercise price that did not reflect FMV on the date of grant. Announcement 2007-18 does not appear to cover the exercise of any options or SARs that were subject to section 409A for any other reason.
  • The program does not affect tax issues outside of section 409A, including employment tax and information reporting issues that may arise from the failure of a purported incentive stock option to meet the applicable ISO requirements or any section 162(m) implications.
  • The payment by the employer of the additional section 409A taxes on behalf of an employee will be taxable income to the employee in 2007 and will be “wages” for employment-tax purposes (FICA, FIT, and FUTA).

Summary of Program Requirements:

  • Notice to IRS of Intent to Participate: Must be filed with the IRS by February 28, 2007.
  • Notice to Affected Employees: Must be sent within 15 days after Notice of Intent to Participate telling any potential employees of program.
  • Second Notice to IRS: Must be sent within 15 days after Notice of Intent to Participate, generally including information about number of employees affected.
  • Submission and Payment to IRS: Required by June 30, 2007 and must include payment of taxes and detailed information concerning affected employees.
  • Notice to Affected Employees of Submission and Payment. Must be sent by July 15, 2007 and inform affected employees of the submission.

The plethora of filings required under this program may be burdensome and will require quick company action. If your company had discounted options or SARs that were exercised in 2006 by a substantial number of non-insider employees, however, this program gives you the opportunity to relieve or mitigate the administrative and tax burden imposed on those employees under section 409A. Companies with corporate insiders who exercised discount options or SARs will need to review their approach for addressing the section 409A consequences of such exercise.

Update Regarding NQDC Legislation

As we described in our prior alerts (for copies, click here and here), on February 4, 2007, the Senate approved in its version of minimum wage legislation (H.R. 2) dramatic changes to the rules governing deferred compensation as part of a larger package providing tax relief for small businesses. Among other changes, these new rules would limit annual deferrals of deferred compensation subject to section 409A (and earnings on deferrals) to the lesser of $1,000,000 or the employee’s average annual compensation and would expand the scope of the section 162(m) deduction limitation.

On February 12, the House Ways and Means Committee approved its version of a bill providing tax relief for small businesses (H.R. 976), which does not include the limitations on deferred compensation and section 162(m) changes that are in the Senate bill. The House is scheduled to vote on the Ways and Means bill today, and assuming the bill is passed without change, the House and Senate will need to work out the differences. We will continue to monitor the situation, since the proposed changes to the rules governing deferred compensation and section 162(m) may be raised again in the future, either as part of the minimum wage and small business tax relief legislation, or as part of future legislation.

For further information, please contact any of the following lawyers:

Fred Oliphant, foliphant@milchev.com, 202-626-5834

Anthony Provenzano, aprovenzano@milchev.com, 202-626-1463

Gary Quintiere, gquintiere@milchev.com, 202-626-1491


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