IRS Stock Option Tax Faces Challenge

WASHINGTON (AP) - Corporate lobbyists and members of Congress are lining up to oppose a plan by the Internal Revenue Service to collect payroll taxes on stock options. The benefit is used by high-tech companies and others to attract and motivate millions of employees.

Rules proposed by the IRS would impose the 15.3 percent tax, which funds Social Security and Medicare, on incentive stock options and employee stock purchase plans. That would reverse a 31-year-old IRS position on the issue. The rules would take effect Jan. 1.

Opponents say this amounts to a new tax burden, never authorized by Congress, that would disrupt a form of compensation affecting about 10 million people. Companies would face major administrative hassles as early as this summer, they say, and some employees might be forced to sell shares prematurely to pay the tax.

``Employees like to own a piece of the company. People can say, 'I'm part of this organization,''' said John Scott, director of retirement policy at the American Benefits Council, an industry trade group. ``The financial disincentive of the tax itself, plus the higher administrative costs, might lead to less of these plans being offered.''

Income taxes do not apply when employees are granted options or when they are exercised - that would not change under the IRS proposal. Capital gains taxes must be paid when the stock shares are sold.

Incentive stock options are usually given to employees, often company executives, who then must wait a specific length of time before exercising them. Employee stock purchase plans usually involve discounted stock purchases through paycheck deductions and are available more commonly to rank-and-file workers.

Despite a 1971 ruling to the contrary, the IRS now says the law does not exempt these stock options from payroll tax withholding. The proposed change would require employees and employers to each pay a 6.2 percent tax to Social Security on the first $84,900 of a person's earnings and a 1.45 percent tax each on the employee's total income to Medicare.

Dozens of companies and trade groups are lobbying Congress and the Treasury Department to block the plan. They include high-tech companies such as Apple Computer Inc., Oracle Corp. and Cisco Systems, and more traditional businesses such as Kellogg Co., Marriott International Inc., and Sears, Roebuck and Co. An American Benefits Council Internet site has generated nearly 20,000 letters from employees and companies in opposition.

Their efforts have begun to pay off. Tucked quietly into a pension bill passed by the House last month is a provision by Rep. Amo Houghton, R-N.Y., that would exclude these stock options from the payroll tax wage base. Sens. Hillary Rodham Clinton, D-N.Y., and Pat Roberts, R-Kan., have introduced similar legislation in the Senate.

Ten members of the Senate Finance Committee recently told Treasury Secretary Paul O'Neill in a letter that the IRS proposal appears to run counter to congressional intent regarding stock options. At the very least, they said, the Jan. 1 effective date should be delayed so the ``potential adverse effects'' of the rules could be carefully examined.

``We urge the administration to reconsider the issuance of these proposed rules before finalizing them,'' said the letter, written by Sens. Jeff Bingaman, D-N.M., and Orrin Hatch, R-Utah.

Many opponents are planning to testify next week at an IRS hearing on the proposed rules.

Pamela Olson, the acting assistant Treasury secretary for tax policy, said the administration would consider delaying the effective date if putting change into place proves too burdensome. She said the IRS is on solid legal ground but that Treasury would not oppose a congressional effort to stop the new rules.

Halting the IRS proposal would reduce projected payroll taxes by more than $23 billion over the next decade, according to congressional estimates. Social Security officials have said that would have a negligible impact on the financial health of the retirement program.

Tucked quietly into a pension bill passed by the House last month is a provision by Rep. Amo Houghton, R-N.Y., that would exclude these stock options from the payroll tax wage base. Sens. Hillary Rodham Clinton, D-N.Y., and Pat Roberts, R-Kan., have introduced similar legislation in the Senate.

Eek!

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