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Throughout 2003, this column has focused on the fallout from Enron on executive compensation in the JCT Staff Report and in various legislative proposals and administrative pronouncements. As this year draws to a close, it is appropriate to summarize and discuss a variety or hodgepodge of equity compensation guidance, legislation, and issues that have emerged of late.
For many years, practitioners have been providing assistance to their clients with respect to equity compensation, relying on guidance that has not kept pace with the increasing complexity of transactions. Although for practitioners such a situation can be fun and encourages creativity, it is less certain for their clients. Also, occasionally the uncertainty in the area encourages taxpayers or practitioners to become more inventive than may be judicious.
Recently, the Internal Revenue IRS (IRS) and the Treasury have issued significant amounts of authoritative guidance (guidance other than private letter rulings) to fill some of the gaps. The Treasury and the IRS are staking out positions on long-neglected issues in more broadly applicable rulings and in regulations.
Clearly, some of the impetus for the issuance of guidance comes from the abuses shown in the recent corporate scandals such as Enron, WorldCom, and Tyco. (1) Perhaps the Treasury and the IRS have felt freed from the restraints that they may have perceived were imposed on them under the Revenue Act of 1978 Section 132, P.L. 95-600, and from the "customer service" attitude of the 1990s. In any event, some taxpayers and practitioners welcome the guidance as an aid in navigating these tax-shelter infested waters that provides more certainty in determining the appropriate tax treatment of selected transactions.
Certain more recent legislative proposals primarily addressing deferred compensation arrangements have potential application (whether intended or not) to equity compensation as well. Most of the legislative proposals have arisen in response to the corporate scandals that became public over the last three years, as we discussed in previous articles for this column. (2)
For example, Congressman Bill Thomas, House Ways and Means Committee Chairman, introduced his American Jobs Creation Act of 2003, (H.R. 2896) on July 25, 2003. His proposal contains various executive compensation provisions, including one tightening the rules for taxation of deferred compensation. The language in Section 1091 of the bill would add new Internal Revenue Code (IRC) Section 409A to provide special rules for inclusion in income of deferred compensation under nonqualified deferred compensation plans. The provision apparently was designed to deal with perceived abuses such as acceleration clauses and subsequent elections in such plans. Section 409A(d)(1) contains a broad definition of nonqualified deferred compensation plans that can be read to extend to discounted stock options. The language is as follows:
The term "nonqualified deferred compensation plan" means any plan that provides for the deferral of compensation other than-- a qualified employer plan, and any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan.
In the lengthy history of the development of the tax treatment of stock options, options have been viewed in a general sense as deferred compensation. Certainly, if the exercise price is less than the fair market value of the stock at grant, i.e., discounted, the amount of the difference is deferred until the option is exercised.
Whether this provision was intended to apply to stock options is unclear. If it does apply, the result would be to subject discounted stock options whether to acquire employer stock or other property to taxation upon grant or when the option was fully vested. This would put employees of taxable corporations on par with employees of tax-exempt employers. IRS providers of tax-exempt entities are taxed on discounted stock options under the recently finalized regulations under IRC Section 457(f) in the same manner as ineligible deferred compensation--at the time there is no substantial risk of forfeiture.
Recently enacted legislation has had some effects on equity compensation. Section 302 of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27), lowers the tax rate on dividends on …