Code V reporting on nonstatutory stock options: December 14, 2001.

On December 14, 2001, Tax Executives Institute submitted the following letter to the U.S. Department of the Treasury and the Internal Revenue Service on an IRS notice requiring the separate information reporting of the compensatory element of nonstatutory stock options. The comments were prepared under the aegis of TEI's Federal Tax Committee whose chair is Mitchell S. Trager of Georgia-Pacific Corporation.

On September 18, 2001, the Internal Revenue Service issued Announcement 2001-92, 2001-39 I.R.B. 301, which extends until 2003 the optional period for separate reporting of any compensation arising from the exercise of any employer-provided nonstatutory stock options. The Announcement also requests comments on cost-effective alternatives for reporting such income. In the absence of subsequent guidance modifying or eliminating the separate reporting requirement first announced in Announcement 2000-97, Announcement 2001-92 states that the amount of compensation from the exercise of nonstatutory stock options included in boxes 1, 3, and 5 must also be shown separately in box 12 of Form W-2, using Code V.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. TEI has nearly 5,300 individual members who represent more than 2,800 of the leading corporations in the United States, Canada, and Europe. It represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, promoting the uniform and equitable enforcement of the tax laws, and reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that is both administratively sound and ensures tax compliance in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We continue to believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by Announcement 2001-92.

Recommendation

TEI strongly urges the government to eliminate the Code V reporting requirement. In addition, while appreciating the extension of the period for optional reporting of compensation arising from the exercise of employer-provided nonqualified stock options, we believe that Announcements are an improper means through which to impose a mandatory wage-information reporting requirement.

Discussion

Absence of Tax-Compliance Justification. The spread between the option price and the fair market value of the employer-provided stock at the date of exercise of a nonqualified stock option constitutes wages. Like all other wages, the compensatory spread is subject to income and FICA tax withholding and is reported as a component of the total amount of wages in Boxes 1, 3 (up to the FICA wage base), and 5 of the annual Form W-2 (or W-2c). As is more fully explained in TEI's previous comments of August 17, 2001, there is no compelling tax compliance justification for mandatory separate reporting.

Employer Administrative Burdens Not Considered. At first glance, the change in reporting practice should seemingly be simple to implement because the spread is already reported as part of total compensation on Form W-2. Even the simplest system changes, however, impose administrative burdens that are unwarranted in the absence of a compelling justification.

Lack of Authority for Announcements 2001-92 and 2000-97. Neither the Internal Revenue Code nor the applicable regulations authorize or require Code V reporting. As is more fully explained in TEI's previous comments, sections 6041 and 6051 authorize the Internal Revenue Service to mandate the collection and reporting of compensation information. Neither statute, however, specifies separate reporting of the spread between the nonqualified stock option price and its fair value. Moreover, the statements required to be furnished under sections 6041 and 6051 must, by the literal terms of the statutes, be prescribed by regulations. Since the regulations under sections 6051 and 6041 do not require the segregation and separate reporting of the spread, the IRS has no express authority to require such reporting and, accordingly, any mandate to comply is questionable. Hence, the Announcement should be withdrawn.

Failure to Heed IRPAC Recommendation. The Information Reporting Program Advisory Committee (IRPAC) was established to provide beneficial feedback and recommendations to the IRS in respect of information reporting issues of concern to the government and the private sector. On August 8, 2001, IRPAC urged the IRS to withdraw Announcement 2000-97 and abandon the separate reporting requirement using Code V. (1) We regret that the Treasury Department and IRS have failed to heed IRPAC's recommendation. We strongly encourage the government to reconsider that recommendation, withdraw Announcements 2000-97 and 2001-92, and eliminate the Code V reporting requirement.

Possible Alternative Reporting Approaches

Because there has been no public disclosure of the rationale for the imposition of the separate reporting requirement, TEI is unable to respond to the request that is set forth in section IV of Announcement 2001-92 and provide meaningful recommendations for cost-effective alternatives. Indeed, requesting taxpayers to supply recommendations without disclosure of the use to which the information will be put or the objectives served by separate reporting is akin to asking them to fire a weapon -- blindfolded. How can one be reasonably expected to hit the target -- cost-effective alternative reporting -- without an indication of the direction in which he or she should aim? As already noted, the information relating to the spread arising from the exercise of nonqualified stock options is fully reported in Boxes 1, 3, and 5 of Form W-2. Neither Announcement discloses any reason for more detailed reporting rules. Moreover, there has been no change in the law governing the treatment of nonqualified stock option exercises to dictate or justify the new reporting requirement. Nor, as is discussed more fully in our previous comments, is there any compelling justification for the change. Indeed, as long as the spread is treated as ordinary wages and reported in Box i of Form W-2, the IRS has sufficient information to examine the employee's tax return, employees have sufficient information to compute their tax liabilities, and the Social Security Administration has the information it needs to properly compute benefits.

TEI urges the government to articulate the objectives of the separate reporting requirement and the rationale for this change in the longstanding rules governing stock options. In the absence of such disclosure, we suggest that it is incumbent on the government to supply for public comment any alternative cost-effective reporting mechanisms, including econometric or statistical studies, SEC filings, or aggregate corporate tax-return data.

Conclusion

Because of the lack of authority and compliance justification for imposing a separate reporting requirement and the administrative burdens imposed on employers to implement it, TEI strongly recommends that Announcement 2001-92 (and its predecessors) be withdrawn. Failing that, and only if necessary to ensure taxpayer compliance with current laws, the reporting requirement set forth in the Announcement should be issued in the form of proposed regulations so that taxpayers are afforded the benefit of the formal notice-and-comment period provided by the Administrative Procedures Act and longstanding Treasury practice.

These comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Mitchell S. Trager. If you have any questions about the Institute's comments, please contact Mr. Trager at 404.652.2690, or Jeffery P. Rasmussen of the Institute's staff at 202.638.5601.

(1) The August 8, 2001, IRPAC letter is included in the materials distributed in connection with the public meeting held on November 1, 2001.