Option levy opposed as unfair, hard to collect


WASHINGTON - Representatives from Marriott Corp., Ciena Corp., Texas Instruments Inc. and Microsoft Corp. asked the IRS yesterday to halt a planned payroll tax on some stock options, describing the levy as regressive and difficult to collect.

"This tax will disproportionately affect rank-and-file employees," David Sherwood, benefits tax counsel for Microsoft, told Internal Revenue Service officials at a hearing. He and nine other witnesses urged the IRS to withdraw or delay the tax.

The IRS says the 15.3 percent tax on incentive stock options and employee stock purchase plans is legal and will go into effect in January. It would reverse 30 years of tax-preferred treatment of the options and would cost companies and their employees $23 billion over 10 years, according to congressional estimates.

Companies say the tax would be impossible to administer and would force them to stop their options programs, and they are lobbying lawmakers to stop the tax. The House of Representatives has passed legislation that would do that. A similar bill is planned in the Senate.

The IRS says its proposal was prompted by changes in the tax laws in the 1980s and the proliferation of employee stock ownership in the 1990s.

The tax would apply to the spread between the fair market value and the exercise price of incentive stock options and shares purchased as part of a qualified employee purchase plan. Such plans typically offer shares at a 15 percent discount from fair market value.

The 15.3 percent payroll tax includes a 12.4 percent tax used to fund Social Security and a 2.9 percent tax used to fund Medicare. Both portions are split evenly between employer and employee. The Social Security tax is imposed on the first $84,900 of salary this year; there is no limit on the Medicare tax.

About 15.7 million people participate in 4,000 company-sponsored stock purchase plans, according to the National Center for Employee Ownership.

Incentive stock options and employee stock purchase plans have tax incentives that encourage owners to hold the stock for at least a year.

They differ from ordinary employee stock options, which are usually exercised and sold on the same day and are taxed as ordinary income at rates of up to 38.6 percent. Companies get a tax deduction and must keep track of when their employees exercise ordinary options.

Witnesses told IRS officials yesterday that the payroll tax on options offered to rank-and-file workers would be impossible to administer because payroll taxes, usually withheld from paychecks, can't easily be collected from the exercise of options. In some cases, companies would be forced to pay the employee share of the tax for workers who have left the company or died.

The witnesses said employees exercising the options and who lack cash with which to pay the tax would be forced to sell shares, thereby giving up other tax incentives to hold those shares for a year.

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