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Consulting Firm Comments on Proposed Regs on Reporting Stock Options

OCT. 9, 2008

Consulting Firm Comments on Proposed Regs on Reporting Stock Options

DATED OCT. 9, 2008
DOCUMENT ATTRIBUTES

 

October 9, 2008

 

 

CC:PA:LPD:PR (REG-103146-08)

 

Room 5203

 

Internal Revenue Service

 

PO Box 7604,

 

Ben Franklin Station,

 

Washington, DC 20044

 

 

To Whom It May Concern:

This letter is submitted by Stock & Option Solutions, Inc. to comment on proposed rules on Information Reporting Requirements Under Internal Revenue Code Section 6039.

Stock & Option Solutions, Inc. is a consulting firm for the equity compensation industry providing guidance and expertise to our corporate clients who issue stock options and provide employee stock purchase plans (ESPPs) for their employees' benefit. We and our clients are directly involved in the design, oversight, and administration of stock compensation programs. Our clients include corporate issuers from all regions of the U.S. and a wide spectrum of industries. We are in our tenth year of business, have serviced over 400 clients and have over 500 years of combined experience in the equity plan industry.

First, we would like to applaud the IRS for the unexpected but welcome expansion of Section 6039 requirements for reporting of transfers of stock pursuant to the employee's exercise of an option described in section 423(c) -- a 423-qualified ESPP. Expanding the requirements to include the necessary information needed to calculate income taxes will certainly be a welcome addition for the many ESPP participants across the country.

Our comments on the proposed rules target the underlying regulation more substantially than the new additions to the regulations, on areas that have long been in question, but we feel clarification on some historic issues would be gratefully received across the equity compensation issuer, consultant, and advisory community.

Definition of "Transfer" for Options Described in Section 423(c)

For 423-qualified ESPP plans, Section 6039-2 requires the reporting to the participant (and soon to the IRS) at the time of "transfer" of the "legal title" of the stock.

 

"Section 1.6039-1(b) of these proposed regulations would require every corporation which records a transfer of the legal title of a share of stock acquired by the employee where the stock was acquired pursuant to the exercise of an option described in section 423(c) to file a return with respect to each transfer made during a particular year." [emphasis added]

 

A long-standing question in the field of equity compensation is "what constitutes a 'transfer of the legal title?'" Some feel that it is the first transfer of legal title, even if the beneficial owner of the stock does not change (such as with a transfer from one brokerage firm to another while still being held for the benefit of the employee). Others argue that only the first transfer of shares in which the beneficial ownership of the shares changes triggers the requirement.

Private Letter Ruling 91107022, dated January 22, 1991 states:

 

"Section 6039(a) of the Code provides, in pertinent part, that every corporation which in any calendar year records (or has by its agents recorded) a transfer of legal title of a share of stock acquitted by the following calendar year furnish to that person a written statement in such manner and setting forth such information as the Secretary may by regulation prescribed. Section 6039(b) provides that this statement is required only with respect to the first transfer of such a share by the person who exercised the option.

Under the terms of the Plan here, if an employee exercises the purchase option, payroll deductions are used by the Agent to purchase stock in the employee's name. Although title to the stock is formally placed in the Agent through the issuance of a certificate in the Agent's name on each Purchase Date, in fact there has been no transfer of title by or on behalf of the participating employee then or in the event that a certificate is issued to the employee under the circumstances listed earlier.

Based on the foregoing, we rule that under section 6039(a)(2) of the Code:

(1) No statement to a Plan participant is required when the certificate is issued in the name of the Agent (or its nominee) on a Purchase Date with respect to the shares purchased on behalf of a participant.

(2) No statement to a participant is required on the transfer of record title to shares of stock from the Agent (or its nominee) to the participant through the issuance of a certification registered in the name of that participant."

 

Further IRS Chief Counsel Memorandum 200114001 states:

 

"The written statement requirement does not apply to the transfer of the stock to the corporation's transfer agent or a nominee agent on behalf of the employee." [emphasis added]

 

Prevalent Practice

Over the last several years, it has become common practice to, subsequent to the periodic purchases (exercises) by the ESPP participants, deposit the shares into a brokerage account for the participant.

Based on the language in Section 6039, we believe that this initial deposit of the shares, in the employee's brokerage account, at the time of the exercise/purchase does not trigger the reporting requirements of section 6039 since the broker is in fact acting as a "nominee agent" for the participant.

However, what if the employee then transfers these shares from Broker A to Broker B still holding these shares in accounts in the name of the employee? Does this trigger the reporting requirements referenced above?

Since the requirement states "a transfer of the title to stock", and since the transfer of shares from one brokerage firm to another (while still held for the benefit of the employee) is, in fact a transfer of legal title, many advisory firms have concluded that the first transfer after purchase, even if to another brokerage account, triggers a reporting requirement. Very few issuing firms have any means to comply with these reporting requirements.

This common interpretation is inconsistent with the perceived goal of the requirement, which is to provide the employee (and now the IRS) with much of the necessary information to complete their tax return. The transfer of shares from one brokerage account to another is not a taxable event and the subsequent sale of shares from the account at Broker B therefore no longer triggers the reporting requirement of section 6039, since it only applies to "the first transfer". So the "wrong" event is being reported.

Therefore, we respectfully request that the IRS clarify the definition of "transfer" and ask that the IRS consider revising this regulation to base its reporting requirement on the taxable event, the disposition of shares (whether qualifying or disqualifying), rather than at the time of transfer of the shares. Because issuing firms are already tracking dispositions of ESPP shares, for both qualifying and disqualifying dispositions of stock, this revision to the reporting requirements would make the reporting requirements of Section 6039 consistent with taxable income reporting requirements and would simplify processes for issuer firms, the employee and provide the IRS with more information at the actual taxable event.

Does Section 6039 Apply to All ESPP Transfers? Or Only Qualifying Transfers?

When defining requirements for ESPP reporting, Section 6039 specifically references Section 423(c), but section 423(c) applies only to qualifying dispositions under a 423-qualified plan. Therefore does Section 6039 only apply to a qualifying transfer?

Or does this specific reference to Section 423(c) denote that Section 6039 only applies upon a transfer of shares acquired under a plan where the purchase price is less than 100% of the fair market value on the date of grant?

§ 6039 States:

 

(a) Furnishing of information

 

Every corporation --

(1) which in any calendar year transfers to any person a share of stock pursuant to such person's exercise of an incentive stock option, or

(2) which in any calendar year records (or has by its agent recorded) a transfer of the legal title of a share of stock acquired by the transferor pursuant to his exercise of an option described in section 423(c) (relating to special rule where option price is between 85 percent and 100 percent of value of stock), shall (on or before January 31 of the following calendar year) furnish to such person a written statement in such manner and setting forth such information as the Secretary may by regulations prescribe. [emphasis added]

Section 423(c) states:

 

Special rule where option price is between 85 percent and 100 percent of value of stock. If the option price of a share of stock acquired by an individual pursuant to a transfer to which subsection (a) applies was less than 100 percent of the fair market value of such share at the time such option was granted, then, in the event of any disposition of such share by him which meets the holding period requirements of subsection (a), or in the event of his death (whenever occurring) while owning such share, there shall be included as compensation (and not as gain upon the sale or exchange of a capital asset) in his gross income, for the taxable year in which falls the date of such disposition or for the taxable year closing with his death, whichever applies, an amount equal to the lesser of --

 

(1) the excess of the fair market value of the share at the time of such disposition or death over the amount paid for the share under the option, or

(2) the excess of the fair market value of the share at the time the option was granted over the option price. If the option price is not fixed or determinable at the time the option is granted, then for purposes of this subsection, the option price shall be determined as if the option were exercised at such time. In the case of the disposition of such share by the individual, the basis of the share in his hands at the time of such disposition shall be increased by an amount equal to the amount so includible in his gross income. [emphasis added]

We respectfully request that, the IRS provide clarification as to whether Section 6039 reporting requirements apply to all transfers of stock or only those that are related to qualified dispositions.

Additional Information or Equivalent Information?

With the revised and expanded reporting requirements for ESPP transfers, the proposed regulation states:

 

"In crafting these proposed regulations, one principal objective was to require corporations to furnish employees with sufficient information to enable them to calculate their tax obligations upon disposition of the shares acquired by the exercise of a statutory option. . . .

With respect to an employee's transfer of stock acquired under an employee stock purchase plan, the information required to be furnished to employees pursuant to the existing regulations under § 1.6039-1 is not sufficient to enable the employee to calculate his or her tax obligations upon disposition of the shares. Accordingly, these proposed regulations would require that additional information be included in the information return and the statement furnished to employees." [emphasis added]

 

To compute taxes correctly upon disposition, ESPP participants may need all of the following (depending on whether the disposition is a qualifying or disqualifying):

 Information                             Section 6039 Requirement #

 

 

 1. Market Value on Grant Date              2iv

 

 

 2. Purchase Price                          2v

 

 

 3. Market Value on Exercise                2vii

 

 

 4. Shares Sold                             2ix

 

 

 5. Sales Price

 

 

 6. Discount %

 

 

As shown above, two of the required elements are not provided by the proposed requirements of section 6039 that would allow participants to compute their taxes accordingly. The participants Sales Price can likely be obtained by some other means, such as a confirmation of sale document from the participant's brokerage firm, but Discount % may not be a readily available data element for the participant. And though it may seem that participants should already be aware of the discount percent available via their ESPP, in practice this is not always the case.

Many issuing companies include information that will allow participants to compute their taxes, but not necessarily the information prescribed by section 6039.1 For example, a statement to the participant may include:

  • Total Purchase Price

  • Total Sale Price

  • Total Discount on Subscription Date

  • W-2 Income (based on the "lesser of" calculation)

 

Though the statement does not comply with the "letter of the law" according to the proposed regulation, it does comply with the intent of the regulation, in fact providing more and easier-to-use information than the information included in the proposed requirements of Section 6039.

Would supplying sufficient information to compute participant taxes be acceptable or must each required element be present in the reporting to the participant? Instead of requiring specific elements that must be included in the reporting, perhaps the regulation could instead require issuer firms to provide "sufficient information to enable the employee to calculate their taxable obligations upon disposition of their shares, but provide that if other information is supplied that enables the employee to compute their taxable obligations, the reporting requirement is deemed to have been satisfied." In this manner, the statements that are already being provided to participants by most issuer firms would not have to be changed to include more, but largely unnecessary information.

Substitute Forms

For many forms that must be submitted to individuals to report taxable events or wages, a substitute format is also allowable. Some examples of forms for which issuing companies and other firms commonly employ substitute forms are 1099B and W-2 forms. These forms have several benefits, the largest of the which, in our opinion, is the ability to include multiple transactions on a single sheet of paper, rather than including only one transaction per form. Permitting a substitute form where many transactions for the year may be reported together would substantially decrease the cost of complying with the revised regulations (most issuer firms to our knowledge currently send one end-of-year statement to each employee with all required elements), both in paper and postage and would also decrease the detrimental environmental impact.

We would like to suggest that the IRS consider allowing substitute forms for the proposed forms 3921 (for ISOs) and 3922 (for ESPPs) so that multiple transactions during the calendar year can be reported to both the employee and the IRS in aggregate.

Applicability to Non-US Participants

Is the reporting requirement of Section 6039 applicable to non-US as well as US participants? Section 6039 refers to "any person" but it seems inconsistent with the perceived purpose of the regulation to require this reporting for only participants that are subject to US taxation.

Since these plans are tax-qualified plans only for US taxpayers, for persons who are not US taxpayers (who do not have a Social Security Number) could the reporting requirement, both to the IRS and to the employee, be waived?

We respectfully request the IRS consider clarifying this in its final regulations.

SSN or ID?

Section 6039 states that the "identifying number" must be included on the report to the employee. In practice it seems that most companies use the participant's Social Security Number (SSN). However, some companies are not comfortable including Social Security Number on this statement and are substituting it with an employee ID. Is this an acceptable practice?

In addition, if SSN is the required ID, what ID should be used by issuer firms who have non-US plan participants?

We respectfully request that the IRS clarify which identifying number should be included on these forms and what identifying number should be used when no SSN is available.

We thank you for this opportunity to share our thoughts on these proposed regulations. We would welcome the opportunity to discuss any of these matters further with members of the IRS staff, respond to questions, and provide additional information. Thank you for your time and consideration. If you have any questions regarding this letter, please do not hesitate to contact me at (650) 773-2142 or edodge@sos-team.com.

Sincerely,

 

 

Elizabeth Dodge, CEP

 

Vice President, Product Management

 

Stock & Options Solutions

 

FOOTNOTE

 

 

1 A widely-used, commercially available software provides a participant statement with the information described here.

 

END OF FOOTNOTE
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