Rev. Rul. 71-52

Advice has been requested whether a company was (1) liable for the Federal employment taxes and (2) required to report amounts with regard to ordinary income that resulted upon a disqualifying disposition of stock acquired by the exercise of a qualified stock option described in section 422(b) of the Internal Revenue Code of 1954.

The ordinary income (as distinguished from long term capital gain) resulted when an employee and two former employees of the company disposed of shares of stock purchased by them as eligible employees under its qualified stock option plan. One of the former employees was an employee of the company during a part of the calendar year in which he disposed of the stock acquired under his stock option. The other individual was not an employee of the company during any part of the calendar year in which he disposed of the stock acquired under his stock option.

The specific questions presented are: (1) Whether the taxable amounts realized by the employee and the former employees upon the disqualifying disposition were wages for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954) and (2) whether such amounts must be reported by the employer on Form W-2, Wage and Tax Statement, or Form 1099, U.S. Information Return for Calendar Year.

Section 422(a) of the Code provides, in part, that in general section 421(a) of the Code shall apply with respect to the transfer of a share of stock to an individual pursuant to his exercise of a qualified stock option if no disposition of such share is made by the employee within the three-year period beginning on the day after the day of the transfer of such share and if at all times during the period beginning with the date of the granting of the option and ending on the day three months before the date of such exercise, the individual was an employee of either the corporation granting the option or a subsidiary thereof. Section 421(a)(1) provides, with an exception not involved here, that if a share of stock is transferred to an individual in a transfer in respect of which the requirements of section 422(a) are met, no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share.

Under section 1.421-8(b) of the Income Tax Regulations the disposition of a share of stock, acquired by the exercise of a statutory option before the expiration of the applicable holding period as determined under section 422(a)(1), 423(a)(1), or 424(a)(1), makes section 421 inapplicable to the transfer of such share. The income attributable to such transfer shall be treated by the individual as income received in the taxable year in which such disposition occurs.

It is concluded in the instant case that the company did not make a payment of "wages," for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, or the Collection of Income Tax at Source on Wages at the time of the exercise of the options granted to the employees participating in its properly qualified stock option plan. It is also concluded that the disposition of shares of stock purchased by the eligible employees under the plan did not result in the receipt of additional "wages" by them or in the payment of "wages" by the company as their employer for such purposes, even though all or a portion of the gain resulting from the disposition of such shares of stock is includible in their gross incomes as ordinary income.

Accordingly, it is held in the instant case that liability was not incurred for the Federal employment taxes in respect of income to the employee or the former employees with regard to gain resulting from the disposition of the stock transferred to them as eligible employees pursuant to the provisions of the company's plan.

It is also held that the income of the optionee who is an employee of the company and of the optionee who was an employee of the company during a part of the calendar year of the disposition must be reported as "other compensation" on Form W-2 if such income is $600 or more for the calendar year or if the total of such income and the employee's wages (subject to income tax withholding) amount to $600 or more. The income of the optionee who was not an employee of the company in the calendar year of disposition must be reported by the company on Form 1099, if such income was $600 or more. However, the above reporting is required only if the information necessary to determine the amount of such income is available to the company.