n-01-14.pdf

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Part III - Administrative, Procedural, and Miscellaneous
Application of Employment Taxes to Statutory Options
Notice 2001-14
I. Purpose and Overview
This notice is intended to clarify the application of FICA, FUTA and income tax
withholding to statutory stock options. With respect to incentive stock options (ISOs)
described in section 422(b) and options granted under an employee stock purchase
plan (ESPP) described in section 423(b) (collectively, “statutory options”), the notice
• provides that, in the case of any statutory option exercised before January 1,
2003, the Service will not assess FICA tax or FUTA tax upon the exercise of the
option and will not treat the disposition of stock acquired by an employee
pursuant to the exercise of the option as subject to income tax withholding;
• concludes that Rev. Rul. 71-52 is obsolete and that the holding of Rev. Rul. 71-
52 does not apply to the exercise of statutory options or to the disposition of
stock acquired pursuant to the exercise of statutory options; and
• announces the intent to issue further administrative guidance to clarify current
law with respect to FICA tax and FUTA tax on statutory options and to address
the issue of whether the disposition of stock acquired by an employee pursuant
to the exercise of a statutory option will be subject to income tax withholding.
This notice invites public comment on this anticipated guidance.
II. Background
A. Income Tax Withholding and Reporting on Options
Income tax withholding is imposed under section 3402(a) of the Internal Revenue
Code of 1986 (Code), which requires employers paying wages to deduct and withhold
income tax on those wages. For income tax withholding purposes, section 3401(a)
provides that the term “wages,” with certain exceptions, means all remuneration for

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services performed by an employee for his employer, including the cash value of all
remuneration (including benefits) paid in any medium other than cash.
The legislative history of sections 3401 through 3404 indicates that a purpose of
income tax withholding is to enable individuals to pay income tax in the year in which
the income is earned. H.R. Conf. Rep. No. 510, 78
th
Cong., 1
st
Sess., at 1 (1943); H.R.
Rep. No. 401, 78
th
Cong., 1
st
Sess., at 1 (1943); S. Rep. No. 221, 78
th
Cong., 1
st
Sess.,
at 1 (1943). Income tax withholding generally is imposed upon remuneration paid by an
employer only to the extent that an employee has income.
Under section 421, no compensation income results when a statutory option is
exercised. Section 421(a) provides that, if a share of stock is transferred to an
individual in a transfer that meets the requirements of section 422(a) or 423(a), no
income results at the time of the transfer. Instead, compensation income is deferred
until the sale or other disposition of the stock acquired pursuant to the exercise of a
statutory option.
Employers making wage payments to an employee (of former employee) that are
subject to income tax withholding generally must report such wage payments on Form
W-2, as provided in section 31.6051-1(a)(1) of the Employment Tax Regulations. Under
certain circumstances, a payment made by an employer to an employee (or former
employee) must be reported on Form W-2 even if the payment is not subject to income
tax withholding. Specifically, section 1.6041-2(a)(1) of the Income Tax Regulations
generally requires reporting if the total amount of the payment and any other payments
of remuneration (including wages, if any) made to the employee (or former employee)

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that are required to be reported on Form W-2 aggregate at least $600 in a calendar
year.
B. FICA and FUTA Tax
Under sections 3111 and 3301, Federal Insurance Contributions Act (FICA) tax and
Federal Unemployment Tax Act (FUTA) tax, respectively, are imposed on the employer
in an amount equal to a percentage of the wages paid by that employer. Under section
3101, FICA tax also is imposed on the employee. Under sections 3121(a) and 3306(b),
the term “wages” for FICA tax purposes and FUTA tax purposes, respectively, means,
with certain exceptions, all remuneration for employment, including the cash value of all
remuneration (including benefits) paid in any medium other than cash. Neither the
Code nor the relevant regulations contain any provision excluding the value of stock
transferred pursuant to the exercise of a statutory option from wages for FICA tax and
FUTA tax purposes.
In 1981, the Supreme Court in Rowan Companies, Inc. v. U.S., 452 U.S. 247, held
essentially that the definition of “wages” for FICA tax and income tax withholding
purposes was the same. As part of the Social Security Amendments of 1983, Pub. L.
No. 98-21, 97 Stat. 65, Congress reversed this holding. Sections 3121(a) and 3306(b)
1
were amended to provide that “[n]othing in the regulations prescribed for purposes of
chapter 24 (relating to income tax withholding) which provides an exclusion from
‘wages’ as used in such chapter shall be construed to require a similar exclusion from
‘wages’ in the regulations prescribed for purposes of this chapter.” This sentence makes
clear that the definition of wages for income tax withholding purposes is not always the

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same as the definition of wages for FICA tax and FUTA tax purposes, and that an item
of income can be wages for FICA tax purposes even if it is not wages for income tax
withholding purposes.
The legislative history of the 1983 provision explains that Congress intended to
reverse the holding in Rowan, and the Senate Report states: “Since the [social] security
system has objectives which are significantly different from the objective underlying the
income tax withholding rules, the committee believes that amounts exempt from income
tax withholding should not be exempt from FICA unless Congress provides an explicit
FICA tax exclusion.” S. Rep. No. 23, 98
th
Cong., 1
st
Sess., at 42 (1983).
C. Administrative Guidance
Revenue Ruling 71-52 (1971-1 C.B. 278) addressed the FICA tax, FUTA tax and
income tax withholding consequences applicable to the exercise of qualified stock
options under former section 422
2
. The ruling holds that a taxpayer does not make a
payment of wages for FICA tax , FUTA tax and income tax withholding purposes at the
time of the exercise of a qualified stock option under former section 422, and that
income realized by employees and former employees from a disqualifying disposition of

1
Sections 3121(a) and 3306(b) were amended by section 327(b)(1) and (c)(4),
respectively, of the Social Security Amendments of 1983.
2
Section 603 of the Tax Reform Act of 1976, Pub. L. No. 94-355, 90 Stat. 1520,
amended former section 422 to provide, generally, that qualified stock options could not
be granted after May 20, 1976. Current section 422 (Incentive Stock Options) was
added to the Internal Revenue Code of 1954, as section 422A, by section 251(a) of the
Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172. Subsequently,
section 11801(c)(9)(A)(i) of the Omnibus Budget Reconciliation Act of 1990, Pub. L. No.
101-508, 104 Stat. 1388, repealed former section 422 (Qualified Stock Options) and re-
designated former Code section 422A as section 422 of the Internal Revenue Code of
1986.

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stock acquired by the exercise of a qualified stock option is also not wages for FICA tax,
FUTA tax and income tax withholding purposes.
Rev. Rul. 71-52 was published before the 1983 statutory changes to sections
3121(a) and 3306(b) described above. In addition, in 1971, the Old-Age, Survivors, and
Disability Insurance (OASDI) contribution and benefit base was only $4,800, as
compared to the current OASDI wage base of $80,400. Further, in 1971, the $4,800
limit applied to the Hospital Insurance (HI) portion of the FICA tax as well as to the
OASDI portion; by contrast, under current law, there is no limit on the amount of wages
for purposes of the HI portion. Accordingly, in 1971, since most optionees had other
wages that equaled or exceeded the FICA wage base, inclusion of option-related
income in FICA wages would have had no effect on the FICA tax liability or Social
Security benefits of most optionees (and no appreciable effect on FICA receipts). Given
the increased wage base for purposes of the OASDI portion of the FICA tax and
removal of the limit on the wage base for purposes of the HI portion, that is no longer
the case.
Notice 87-49 (1987-2 C.B. 355) addresses potential inconsistencies among, and
coordination of, the proposed regulations under section 83, former section 422A
(current section 422), and Rev. Rul. 71-52. Notice 87-49 provides that Rev. Rul. 71-52
is being reconsidered, but until the results of such reconsideration are announced, the
principles of Rev. Rul. 71-52 will apply to the disposition of stock acquired by an
individual pursuant to the exercise of an ISO, which does not meet the requirements of
former section 422A(a) (current section 422(a)).
III. Reconsideration of Rev. Rul. 71-52 and Interim Guidance

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A. Reconsideration of Rev. Rul. 71-52
Treasury and the Service have concluded that the holding and principles of Rev. Rul.
71-52 do not apply to the exercise of ISOs or options granted under an ESPP, or to the
disposition of stock acquired pursuant to such statutory options, and have therefore
determined that Rev. Rul. 71-52 is obsolete. Accordingly, the provisions of Notice 87-49
described above no longer apply.
B. Interim Guidance
In view of the lack of clear administrative guidance regarding the application of FICA,
FUTA, and income tax withholding to statutory options, the Service, with respect to
statutory options exercised before January 1, 2003, will not treat the disposition of stock
acquired by an employee pursuant to the exercise of a statutory option as subject to
income tax withholding and will not assess FICA tax or FUTA tax upon the exercise of a
statutory option.
This Part III.B applies to an exercise of a statutory option and the disposition of stock
acquired by an individual pursuant to the exercise of a statutory option, if the exercise
occurs on or after publication of this notice and before January 1, 2003. However,
employers may, at their option, choose to apply this Part III.B with respect to any
exercise of statutory options, or dispositions of stock acquired by individuals pursuant to
any exercise of statutory options, that occurred before the publication of this notice.
Thus, with respect to exercises of statutory options covered by this Part III.B, the
Service will not require payment of FICA tax or FUTA tax, will not assert penalties or
interest, and will honor otherwise allowable adjustments and claims for refund of any
FICA tax or FUTA tax paid. Furthermore, with respect to dispositions of stock acquired

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pursuant to the exercise of statutory options covered by this Part III.B, the Service will
not require income tax withholding and will not assert penalties or interest. This Part
III.B does not relieve individual taxpayers of the obligation to include any compensation
in income upon a disposition of stock acquired pursuant to the exercise of a statutory
option, and does not relieve employers of any of their reporting obligations.
IV. Request for Comments on Anticipated Administrative Guidance
A. Anticipated Guidance
Treasury and the Service anticipate issuing administrative guidance that will clarify
current law with respect to FICA tax, FUTA tax, and income tax withholding on statutory
options. It is anticipated that the administrative guidance would 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. With respect to the disposition of
stock acquired pursuant to such an exercise, however, it is the view of Treasury and the
Service that there may be authority for future administrative guidance to treat amounts
realized upon such disposition of stock as not being subject to income tax withholding.
Comments are requested regarding the anticipated administrative guidance. In
particular, comments are requested on whether it is appropriate, in light of the issues of
administrative feasibility associated with a requirement of income tax withholding upon
disposition of stock acquired pursuant to the exercise of a statutory option (when the
optionee may no longer be employed by the grantor), to treat amounts realized upon the
disposition as not being subject to income tax withholding. All comments will be
available for public inspection and copying.
B. Prospective Effective Date

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It is anticipated that the administrative guidance described in this Part IV will be
effective only prospectively. However, it is anticipated that employers will be permitted
to apply the guidance to exercises of statutory options that occurred on an earlier date
and to a disposition of stock acquired pursuant to such exercises.
V. Effect on Other Documents
This notice constitutes the result of the reconsideration of Rev. Rul. 71-52, referred
to in Notice 87-49. This notice concludes that the holding and principles of Rev. Rul.
71-52 do not apply to the exercise of ISOs described in section 422(b) or options
granted under an ESPP described in section 423(b), or to the disposition of stock
acquired pursuant to the exercise of such statutory options and, thus, Rev. Rul. 71-52 is
determined to be obsolete. Notice 87-49 is modified to the extent it is inconsistent with
this notice.
VI. Submission of Comments
Comments must be submitted by May 7, 2001. Comments should reference Notice
2001-14, and be addressed to:
Associate Chief Counsel
(Tax Exempt and Government Entities)
CC:TEGE
ATTN: Employment Taxes and Statutory Options
Room 5214
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 20224

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VII. Drafting Information
The principal author of this notice is Stephen Tackney of the Office of Associate
Chief Counsel (Tax Exempt and Government Entities). For further information
regarding this notice contact Stephen Tackney at (202) 622-6040 (not a toll-free call).