• IRS Extends Stock Option Settlement Offer
  • March 20, 2005 | Author: Jonathan A. Clark
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • On February 22, 2005, the IRS announced a settlement initiative for executives and their employers who participated in certain transactions involving the transfer of stock options or, in some cases, restricted stock, to family-controlled entities.

    Typically, the transaction involved the transfer of stock options by an executive to a related entity, such as a family limited partnership, in exchange for a deferred payment to the executive. Next, the entity exercised the options and sold the stock in the marketplace. The executive then took the position that his/her taxes were not owed until the date that he/she actually receives the deferred payment (rather than the date the options were exercised), which is typically 15 to 30 years after the exercise date. During that period, however, the executive generally has access to the partnership assets undiminished by the taxes.

    In 2003, the IRS identified these transactions as prohibited tax shelters (see Notice 2003-47) with the sole purpose of the transaction being the avoidance of taxation on compensation income to the executive. The tax objective was simply to defer for up to 30 years taxes on the compensation, and, in many cases, the deferral of a legitimate compensation deduction for the executive's employer for the same period.

    Executives who participated in these transactions and their employers have until May 23, 2005 to accept the IRS settlement offer to resolve their tax issues. Under the settlement offer, these executives must report 100 percent of the compensation involved and must pay interest and a 10 percent penalty (which is half of the maximum 20 percent penalty that would otherwise apply). Employers will be allowed a deduction for the compensation expense reported by the executive. Executives and employers will be required to pay appropriate employment taxes.

    The IRS has already identified 42 employers and many more executives who participated in this type of transaction. However, the IRS believes that a number of executives have not come forward to disclose their involvement. The IRS has cautioned that it will aggressively pursue executives and employers who participated in these transactions and who fail to participate in this settlement opportunity.

    Pepper Perspective

    For both the executive and his/her employer, the failure to voluntarily come forward and participate in the settlement offer will be harsh. We strongly urge any executive or employer who engaged in the transaction outlined above, or any similar transaction, to call us to discuss how this settlement offer may effect them.