IRS freezes stock tax plan

Tech workers breathe a sigh of relief as the IRS announces it has indefinitely postponed its plan to collect payroll taxes on certain stock-based employee benefits starting next year.

Alorie Gilbert Staff Writer, CNET News.com
Alorie Gilbert
writes about software, spy chips and the high-tech workplace.
Alorie Gilbert
3 min read
Technology workers and their employers breathed a sigh of relief Tuesday, after the Internal Revenue Service said it has indefinitely postponed its plan to collect payroll taxes on certain stock-based employee benefits starting next year.

The plan, announced in November, caused an uproar in the technology industry.

At a hearing before the IRS in May, Microsoft, Texas Instruments and networking equipment maker Ciena joined a number of companies in asking the government to stop the plan. Several tech-lobbying groups, including TechNet, the Information Technology Association of America and the American Electronics Association (AeA) rallied opposition against the plan, and 10 members of the Senate Finance Committee wrote up a condemnation of the plan.

The controversial plan would have imposed payroll taxes on incentive stock options and employee stock purchase plans (ESPPs) beginning Jan. 1, 2003. The taxes already apply to some stock plans, but this rule would extend the taxes to ESPPs and other currently exempt plans that are widely used in the computer industry to recruit and reward staff.

The IRS and the Treasury Department said they have yet to form their final policy on the matter. They may impose the proposed taxes at a later date but need more time to evaluate the concerns of businesses and lawmakers, the IRS said. Those concerns include whether or not the proposed taxes are the correct interpretation of the law and the burdensome logistics of administering taxes on noncash compensation for employers.

"We have decided to extend the moratorium indefinitely," Pam Olson, the Treasury Department's acting assistant secretary for tax policy, said in a statement. "Given the significant administrative changes that would be required of employers to implement the proposed withholding, it is clear that a delay in the effective date is necessary to provide employers with adequate time to make the required changes. In addition, Treasury and the IRS need additional time to consider the many comments we received on the proposed regulations and to decide on an appropriate course of action."

If the government decides to eventually impose the plan, it would give taxpayers two years from the time it issues its final policy before the rule would go into effect, the agencies said.

The push to stop the plan
Critics of the proposed tax--including more than 18,000 workers and 2,000 companies that sent e-mail messages to the U.S Treasury Department and lawmakers in Washington--intend to put a permanent end to the plan.

"The IRS decision (to put the plan on hold) is the right step in the right direction, but we are still working for a significant leap towards a permanent solution, either a permanent ban by the IRS or legislation to ban stock option payroll taxes for lower-paid workers," William Archey, CEO of AeA, said in a statement.

Two bills proposing to block the IRS plan remain before the Senate, which is expected to vote on them this summer. One, sponsored by Rep. Amo Houghton, R-N.Y., is attached to the Pension Security Act, HR 3762, which passed a House vote in April. The other, S. 1383, is sponsored by Sen. Pat Roberts, R-Kan., and Sen. Hillary Clinton, D-N.Y.

Under the proposed rule, which would create $23 billion in taxes over 10 years, employees would immediately owe Social Security and Medicare taxes, about 7.5 percent, on the spread between the exercise price of a stock option and the market price of the stock the day they exercise the option. For ESPPs, workers would owe the taxes on the difference between the discounted price of the stock and the market price on the day they purchase stock under the plan. Employers would be required to pay the IRS a matching amount in both cases.

The rule would not affect the existing requirement that taxpayers report gains from the sale of stock acquired through stock option programs as income and pay any income or capital gains tax owed, the IRS stressed.

Critics say additional taxes would discourage employees and companies from participating in what are some of the most widely used benefits to both attract and retain workers, particularly in the technology industry, which has been hit especially hard by the economic downturn.