Treasury Closes Deferred Stock Option Loophole

by Mike Godfrey, Tax-News.com, Washington

04 July 2003

The Treasury Department this week announced the closure of a tax loophole promoted to executives enabling them to defer income tax on stock option gains beyond the exercise of the option.

The method employed to execute this scheme involves the transfer of stock options to a family member or family-owned limited partnership in which the executive has a significant interest. The executive then receives a long term unsecured note in exchange whilst the relative exercises the option, stating that they will not recognize any gains until it is subsequently sold and then only if the proceeds are more than the price paid for the option and the exercise price. The scheme's promoters claim that no tax needs to be paid on the option until payments are made on the long term note.

The Treasury Department says: "The IRS will challenge the executive’s claim that income from the exercise of the stock options can be deferred. The regulations, which are effective immediately, prevent an executive or any other person from claiming tax deferral from the transfer of options to a related party."

"The notice and the regulations eliminate any question that the arrangements can be used to defer stock option gains," commented Treasury Assistant Secretary for Tax Policy Pamela Olson. "Executives cannot defer income taxes on stock option exercise by purporting to sell their stock options to a family member or family limited partnership."

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