rp-02-50.pdf

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Part I

Income Tax

Rev. Proc. 2002-50

26 CFR 1.6045-1: Returns of Information of brokers and barter exchanges.

(Also Part III, §§ 83, 421, 422, 423, 1001, 1011, 3121, 3306, 3401, 3402, 6041,
6051)

SECTION 1. PURPOSE

This revenue procedure provides an exception from reporting on Form 1099-
B, “Proceeds From Broker and Barter Exchange Transactions”, for transactions
involving an employee, former employee, or other service provider (a “service
provider”) who has obtained a stock option in connection with the performance of
services. Where the service provider purchases stock through the exercise of
the stock option and sells that stock on the same day through a broker, the
broker executing such a sale is not required to report the sale on Form 1099-B,
provided certain conditions are met.
SECTION 2. BACKGROUND
.01 Tax treatment of stock options
. Section 83 of the Internal Revenue
Code governs the tax treatment of nonstatutory stock options granted in
connection with the performance of services. Sections 421 through 424 govern
the tax treatment of statutory stock options,
i.e., incentive stock options described
in § 422(b) and options granted under an employee stock purchase plan

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described in § 423(b). A stock option is not taxable when granted, provided the
option either lacks “a readily ascertainable fair market value” as defined in
§ 1.83-7(b) of the Income Tax Regulations or meets the requirements of § 422 or
§ 423.
For nonstatutory stock options that lack a readily ascertainable fair market
value, the service provider generally recognizes income at the time of the
exercise of the options, in an amount generally equal to the fair market value of
the stock received (disregarding lapse restrictions) minus the amount paid for
that stock. See § 83(a) and § 1.83-7. The time for recognizing this income and
for determining the fair market value of the stock is the first day that the
transferee’s rights in the stock are “substantially vested”,
i.e.
, transferable or not
subject to a substantial risk of forfeiture. Where the individual exercising such
options is an employee, the taxable compensation income generated by § 83(a)
constitutes wages for purposes of §§ 3121, 3306 and 3401.
For statutory stock options, if the individual receiving the statutory stock
option satisfies the employment requirements of § 422(a) or § 423(a), the
exercise of the stock option produces taxable income only when the stock
acquired pursuant to the exercise of the option is sold or disposed of. If that
stock is sold in a disqualifying disposition (
i.e.
, prior to the later of the date that is
one year after the exercise of the option and two years after the grant of the
option), certain amounts will be taxable compensation income under § 83(a). In
addition, pursuant to § 423(c), where the holding periods are satisfied, and where
the stock options under an employee stock purchase plan are offered at an

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exercise price below the fair market value of the stock at the date of grant,
certain amounts may be included as compensation income at the time of
disposition of the stock acquired at exercise of the option.
Notice 2002-47, 2002-28 I.R.B. ____ provides, in part, that until the
Treasury Department and the Internal Revenue Service issue further guidance,
in the case of a statutory stock option, the Service will not assess the Federal
Insurance Contributions Act (FICA) tax or Federal Unemployment Tax Act
(FUTA) tax, or apply federal income tax withholding obligations, upon either the
exercise of the option or the disposition of the stock acquired by an employee
pursuant to the exercise of the option.
Section 1001 dictates the tax consequences when substantially vested
stock obtained through the exercise of an option is sold. Pursuant to § 1001(a),
the gain from sale of the stock is the amount realized minus the adjusted basis
provided in § 1011, and the loss is the adjusted basis provided in § 1011 minus
the amount realized. For this purpose, the adjusted basis of the stock includes
the amount included in gross income under § 83(a) upon exercise of an option
that did not have a readily ascertainable fair market value at grant.
.02 Information reporting – Form W-2 and Form 1099
. Section 6051
provides generally that an employer must annually report to each of its
employees the total wages paid to the employee. Compensation income
constitutes “wages” for purposes of this reporting obligation. Form W-2 is used
to report the information required by § 6051.

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Section 6041 provides that where a person engaged in a trade or
business makes payments in the course of the trade or business to another
person of compensation of $600 or more in a taxable year, the person must
render a return, in accordance with such regulations as the Secretary may
prescribe, that sets forth the amount of the income, and the name and address of
the recipient of the payment. Forms in the 1099 series are generally used to
report the information required by § 6041 where the compensation income does
not constitute wages, such as where the service provider does not provide the
services as an employee of the service recipient.
.03 Information reporting – Form 1099-B
. Section 6045(a) provides that
brokers, when required to do so by the Secretary, must make a return in
accordance with such regulations as the Secretary may prescribe regarding
transactions they carry out for customers.
Section 1.6045-1(c)(2) of the regulations states, in general, that each broker
must make a return of information with respect to each sale by a customer
effected by the broker.
Section 1.6045-1(d)(2) provides, in part, that a broker must report the gross
proceeds of a stock sale.
Section 1.6045-1(d)(5) provides that the broker may, but is not required to,
take commissions and option premiums into account in determining gross
proceeds provided the treatment chosen is consistent with the books of the
broker. Form 1099-B is used to report the information required by § 6045 and
the regulations thereunder.

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Section 1.6045-1(c)(3)(ii) states that no return of information is required with
respect to a sale effected by a broker for a customer if the sale is an excepted
sale. This regulation defines an “excepted sale” as one so designated by the
Internal Revenue Service in a revenue ruling or revenue procedure published in
the Internal Revenue Bulletin.
SECTION 3. SCOPE
.01 Applicability
. The exception provided by this revenue procedure applies
to a sale of stock acquired by a service provider through the exercise of an option
if:
(1) the sale is executed for the service provider on the same day that the
stock being sold is acquired through the exercise of an option;
(2) the option was granted in connection with the performance of services,
such that the federal tax consequences of the transactions are governed
by section 83 of the Code (e.g., an exercise of a nonstatutory stock option
granted in exchange for services or an exercise of a statutory stock option
followed by a disqualifying disposition of the stock acquired pursuant to the
exercise);
(3) the service recipient certifies in writing to the broker that the service
recipient will report any compensation income generated by the exercise
of the option, or disposition of the stock acquired pursuant to the exercise
of the option, in accordance with section 6041 (Form 1099) or section
6051 (Form W-2), as applicable; and
(4) the broker either:

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(a) does not charge a commission or other fee on the transaction; or
(b) does charge a commission or other fee on the transaction and
furnishes to the service provider the written statement
described in section 4.03 of this revenue procedure.
.02 Inapplicability
. The exception provided by this revenue procedure does
not apply if the service recipient uses an amount other than the sale price of the
shares to calculate the compensation income generated to the service provider
by the option exercise. This revenue procedure also does not apply to the
exercise of a stock option if, at the date of grant, the stock option had a readily
ascertainable fair market value as defined in § 1.83-7(b).
SECTION 4. PROCEDURE
.01 General
. A broker may treat a sale as an “excepted sale” for purposes of
§ 1.6045-1(c)(3)(ii) if an employee, former employee or other service provider
obtains substantially vested shares of stock from the exercise of an option and
on the same day sells the shares through a broker.
.02 Statement to broker
. To determine whether the service provider
exercised the option and sold the underlying shares on the same day, the broker
may rely on a receipt or written statement provided by the service recipient or the
service provider showing the date of exercise. To determine whether the service
recipient uses the sale price of the shares to calculate the compensation income
generated to service providers by the option exercise, the broker may rely upon a
written statement from the service recipient certifying that it follows that practice.

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.03 Statement to customer
. Under the circumstances described in section
3.01(4)(b) of this revenue procedure, the broker must furnish the service provider
with a statement containing the following information:
(1) the gross sales price with respect to the shares sold through the broker;
(2) the commissions or other fees charged by the broker on the sale; and
(3) a description of how gain or loss with respect to shares obtained through
the option exercise is calculated and the manner in which such gain or loss
should be reported on a federal income tax return. The description need not
be an independent document, but may be incorporated in a document such
as a settlement sheet provided to the broker’s customer in connection with
the sale.
SECTION 5. EXAMPLES
.01 Example 1
. An employee holds an option for 100 shares of Company A
stock at an exercise price of $20 per share. When granted, the option had no
readily ascertainable fair market value. The employee exercises the option on
January 15, 2003, receives substantially vested shares and immediately sells the
shares for the fair market value of $30 per share. The sale is executed by a
broker rendering its services to Company A employees through a contractual
arrangement with Company A. The broker charges no commissions or other
fees to the employee in connection with the sale of the shares. Company A uses
the sale price of the shares to calculate the compensation income of the
employee reported as wages on Form W-2.

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Under these facts, the employee has compensation income of $10 per share
under § 83(a) ($30 fair market value minus $20 exercise price). Company A
certifies in writing to the broker that it will report $1,000 as wages of the
employee, and includes that amount on the employee’s Form W-2. The
employee’s basis is $30 per share ($20 cost of exercising the option plus $10
taxable income recognized). Because the employee’s amount realized on the
sale of the stock ($30 per share) equals his basis, the employee has no capital
gain or loss on the sale. The broker is not required to report the proceeds of the
sale on Form 1099-B.
.02 Example 2
. Assume the same facts as Example 1, except that the
employee pays a commission of $.05 per share to the broker. The employee’s
compensation income is $10 per share ($30 fair market value of stock received
minus $20 exercise price). Company A reports $1,000 as wages on the
employee’s Form W-2 (as in Example 1), since commission expense does not
reduce the income generated by the exercise. The employee has a loss of $5.00
($.05 per share times 100 shares). Because the employee realizes a loss,
“excepted sale” treatment will apply only if the broker provides the statement
required by section 4.03 to the employee.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective for sales of stock occurring after
December 31, 2001.

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SECTION 7. DRAFTING INFORMATION
The principal author of this revenue procedure is Nathan Rosen of the Office
of the Associate Chief Counsel (Procedure & Administration), Administrative
Provisions and Judicial Practice Division. For further information regarding this
revenue procedure, contact Mr. Rosen at (202) 622-4910 (not a toll free call).