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Notice 2003-47 Settlement Initiative Frequently Asked Questions

March 14, 2005 - Initial FAQs
April 04, 2005 - Additional FAQs 3.7 to 3.10
May 04, 2005 - Additional FAQs 3.11 to 3.13; 4.7 to 4.11 and Misc. 5
May 12, 2005 - Additional FAQs 3.14

(These FAQs are grouped and numbered by the sections of Announcement 2005-19 to which they refer.)

Section 2 – The Parties and Eligibility Requirements

Q-2.1. Is an Executive eligible to participate in the settlement initiative without his employer Corporation?
A-2.1. Yes, but the Related Person to whom the Executive transferred the stock option must also participate in the settlement initiative.  Also, the Executive must disclose the identity of the employer Corporation.

Q-2.2. Is a Corporation eligible to participate in the settlement initiative without one or more of its Executive(s) who participated in the transaction?
A-2.2. Yes, but the Corporation must disclose the identity of all of its current and former Executives who participated in the transaction (by name and TIN).

Q-2.3  If a subsidiary Corporation has awarded stock options to purchase its parent’s stock to Executives of the subsidiary, which Corporation (parent or subsidiary) should file the election form?
A-2.3. Assuming the parent files a consolidated return that includes the subsidiary that awarded the options, the parent and its subsidiary must each file the election form (Form 13657). If the subsidiary is not included in a consolidated return then generally only the subsidiary should file the election form.

Q-2.4  If Executives of a parent Corporation and different Executives of the parent’s subsidiary Corporation that files a consolidated return with the parent have participated in Notice 2003-47 transactions, should the parent respond to the questions in III of Form 13657 for all these Executives?
A-2.4 .  Yes.

Q-2.5  If a consolidated group’s parent and its subsidiary each file an election form where Executives of the parent’s subsidiary have participated in Notice 2003-47 transactions, which Corporation (parent or subsidiary) will sign the closing agreement?
A-2.5  Because the closing agreement will cover both income tax and employment tax matters, both the parent and the subsidiary must sign the closing agreement.

Section 3 - Settlement Terms for Participating Parties

Q-3.1. When do the Executive and the Related Person recognize income, and when is the income ordinary income and when is the income capital gain or loss?
A-3.1.  Under the settlement initiative, the amount of the Executive’s compensation income (ordinary income) is determined as of the time the Related Person exercises the options (or when restricted stock becomes substantially vested) and generally is equal to the “spread” at exercise, which is the difference between the fair market value of the stock acquired less the amount paid to the Corporation to acquire the stock (the exercise price).  In the case of restricted stock, the compensation income generally is equal to the fair market value of the stock when the stock vests.  However, the time for reporting this compensation income may be deferred until the earlier of the taxable year containing December 31,2004 or the year the Related Person sells the acquired stock.  The Executive may also recognize capital gain income to the extent the amount of the deferred payment obligation exceeds the amount of the compensation income recognized by the Executive. 

The amount of the Related Person’s capital gain or loss (if any) is determined as of the year in which the Related Person sells the stock.  The Related Person’s basis in the stock is generally equal to the amount of compensation income and capital gain, if any, recognized by the Executive, plus any exercise price the Related Person paid the Corporation.

The following examples illustrate the application of Section 3(a)(1) and (2) and the FAQ above.  In each of the following examples, the amount of the deferred payment obligation is $1000; the exercise price of the option is $100; there have been no payments on the deferred payment obligation; there was no other consideration provided in exchange for the stock option; and there was no payment by the Executive for the options.

Example 1: The fair market value of the stock on the date the option is exercised is $1100. Therefore the compensation income calculated under the settlement initiative is $1000. [$1100 fair market value - $100 exercise price - $0 paid for the option = $1000.] The Executive’s ordinary income is $1000, the Executive has no capital gain income under the settlement initiative [$1000 deferred payment obligation - $1000 compensation income = $0], and the Related Person’s basis in the stock is $1100. [$1000 Executive ordinary income + $100 exercise price = $1100.] If the Related Person sells the stock immediately upon exercise of the option for its fair market value of $1100, the Related Person has no capital gain or loss. [$1100 amount realized - $1100 basis = $0.]

Example 2: The fair market value of the stock on the date the option is exercised is $1150. Therefore the compensation income calculated under the settlement initiative is $1050. [$1150 fair market value - $100 exercise price - $0 paid for the option = $1050.] The Executive’s ordinary income is $1050.  The Executive cannot deduct the $50 excess over the amount of the deferred payment obligation as a loss.  The Related Entity’s basis in the stock is $1150. [$1050 Executive ordinary income + $100 exercise price = $1150.] If the Related Person sells the stock immediately upon exercise of the option for its fair market value, the Related Person has no capital gain or loss. [$1150 amount realized - $1150 basis = $0.]

Example 3: The fair market value of the stock on the date the option is exercised is $1050. Therefore the amount of compensation income calculated under the settlement initiative is $950. [$1050 fair market value - $100 exercise price - $0 paid for the option = $950.] The Executive’s ordinary income is $950, the Executive has $50 capital gain income [$1000 deferred payment obligation - $950 Executive ordinary income = $50], and the Related Person’s basis in the stock is $1100. [$950 Executive ordinary income + $50 Executive capital gain income + $100 exercise price = $1100.] If the Related Person later sells the stock for $900, the Related Person has a $200 capital loss. [$900 amount realized - $1100 basis  = ($200).]

Q-3.2. May the Executive deduct a capital loss if the Executive reports compensation income pursuant to this initiative in an amount greater than the amount of the deferred payment obligation?
A-3.2. No.  If the amount of compensation income exceeds the amount of the deferred payment obligation, the Executive may not deduct the excess as a capital loss. 

Q-3.4. What is the Executive’s liability for the Executive’s share of FICA tax?
A-3-4. Under the settlement initiative, the Executive must pay the Executive’s share of FICA tax on compensation income, as discussed in Q&A-3.1 above, for the year in which the compensation income is reported under this settlement initiative.   

Q-3.5.  What is the Corporation’s liability for FICA taxes and income tax withholding?
A-3.5. Under the settlement initiative, the Corporation must pay the employer’s share of FICA tax with respect to all Executives of the Corporation that participated in the Transaction whether or not such Executives participate in this settlement initiative.  However, if any Executive of the Corporation who participated in the Transaction does not participate in this settlement initiative, the Corporation must also pay the Executive’s share of FICA tax and the employer’s liability for income tax withholding with respect to that nonparticipating Executive. 

The amount of FICA tax and any income tax withholding paid by the Corporation is determined based on the compensation income (as discussed in Q&A-3.1 above).  The Corporation is responsible for the payment of FICA tax and any income tax withholding for the year in which the Corporation claims a deduction for the compensation income under this settlement initiative.   For purposes of applying the wage base limitation for FICA tax to Corporations with a taxable year other than the calendar year, the relevant year is the calendar year ending during the taxable year in which the Corporation claims the deduction.  Determination of the applicable income tax withholding rate is based on the flat supplemental wage withholding rate applicable for the same year. 

Q-3.6.  How should the Executive, Related Person, or Corporation treat a refund or reimbursement of the fees paid to the accounting firm or other party (or reduction of previously accrued but unpaid fees) relating to the Notice 2003-47 transaction?
A-3.6.  If the refund (which, for purposes of this FAQ, includes any reimbursement or reduction) was received before the Executive or Corporation and the Service execute the settlement agreement, the refund is accounted for by reducing the deduction of fees paid or accrued or, to the extent the fees were properly capitalized, by reducing the amount capitalized.  The closing agreement will provide that if a refund of such fees is received after the settlement agreement has been executed, the refund recipient must recognize income from the refund in the tax year the amount was received.

Q-3.7.  Executive is a partner in the Related Person.  If the Related Person has a loss on the stock (given the basis as determined under the announcement), is the Executive permitted to claim a share of the partnership loss?
A-3.7.  Nothing in the announcement is intended to affect the ability of an Executive who is a partner in the Related Person to claim a distributive share of the partnership’s loss.  Accordingly, the Executive will be permitted to claim their allocable share of the loss if the Executive would otherwise be entitled to claim the loss.

Q-3.8.  May the Corporation’s deduction under Section 3(b)(1) be limited? 
A-3.8.  As indicated in the announcement (as published in the Internal Revenue Bulletin March 14, 2005), the Corporation is permitted to claim the deduction as would otherwise be allowed in the year of transfer, exercise, or vesting.  Accordingly, the deduction must have been otherwise allowed under section 83(h) and the accompanying regulations (other than the timing rules related to the Executive’s inclusion of the income).  Under those rules, an amount is deductible only if it is allowed under section 162 (including section 162(m)) or 212 and the regulations thereunder.  In addition, the amounts may be subject to capitalization.  See § 1.83-6(a)(4).

Q-3.9.  How would the settlement initiative affect an Executive who filed a qualified amended return that reported compensation income related to the Transaction?
A-3.9.  If an Executive filed a qualified amended return for a Notice 2003-47 transaction and the Executive is otherwise eligible for the settlement initiative, the Executive may participate in the settlement initiative.   See Treas. Reg. §§1.6664-2(c)(3), 1.6664-2T, and Notice 2004-38, 2004-21 I.R.B. 949 (May 24, 2004), for the definition of qualified amended return. 

Solely for purposes of determining the amount of the underpayment attributable to the Notice 2003-47 transaction on which the 10 percent penalty should be calculated under Section 3(a)(7), the amount of tax shown on the return is determined as if the taxpayer properly included in gross income in the settlement year, the amount of compensation income from the Notice 2003-47 transaction that was previously shown on an original return of the taxpayer, and on any qualified amended return.  For these purposes, the “settlement year” is the taxable year(s) that compensation income from the Notice 2003-47 transaction is required to be included under the settlement initiative.  Accordingly, if the option was exercised and the taxpayer included compensation income from the exercise on an original return or on a qualified amended return, that income will also be used to determine the amount of tax shown on the return for the settlement year.

As an example, Executive received options in Year 1 and transferred those options in Year 2.  In Year 3, the Related Party exercised the options.  In Year 4, the Service issued Notice 2003-47, at which time Executive filed qualified amended returns for Years 2 and 3, showing additional amounts of compensation income related to the Notice 2003-47 transaction.  The Related Party continues to own the acquired stock.  If Executive participates in the Announcement 2005-19 settlement initiative, the compensation income reported on the Year 2 and Year 3 qualified amended returns (and any compensation income from the option transfer or exercise that had been reported on original returns for those years) will be treated as if it were properly reported on the return for the settlement year, but only for purposes of determining the amount of the underpayment (if any) on which the 10 percent penalty will be applied.

Q-3.10.  On what amount is the ten percent penalty imposed if payments were made on the deferred payment obligation and included by the Executive as compensation income in the years paid?
A-3.10.  If an Executive received payments on the deferred payment obligation in taxable years prior to the taxable year including December 31, 2004, the Executive must include those amounts as compensation income under Section 3(a)(1).  Thus, if the Executive properly included those amounts as compensation income in the year received, there would be no underpayment allocable to those payments and the ten percent penalty would not apply to those amounts.  If the payments were made in the taxable year including December 31, 2004, and the Executive had received prior to February 22, 2005, a Form W-2 including the amounts of the payments made in that taxable year as compensation income for the 2004 calendar year, the amounts are not included in determining the underpayment in 2004 to which the ten percent penalty applies.  However, if payments were made on the deferred payment obligation and not included as compensation income by the Executive in the year received, but are now included due to participation in the settlement initiative, those amounts are included in determining the underpayment to which applies the ten percent penalty under Section 3(a)(7).

Q-3.11. For a Corporation that satisfies its withholding tax liability for a Non-Participating Executive under the settlement initiative, will the IRS repay the amount of withholding tax liability paid by the Corporation if  the Executive subsequently pays the income tax due on the Transaction?
A-3.11. Yes. The closing agreement will provide that the Corporation will be entitled to repayment without interest of the amount of withholding tax liability paid by the Corporation if the Executive subsequently satisfies his tax liability.  The repayment will be subject to the applicable statutory period of limitation.

Q-3.12 If a Corporation must pay Federal Income Tax Withholding for a Non-Participating Executive where the supplemental wages exceed $1 million for the Executive and such Federal Income Tax Withholding payments are paid in 2005, would the mandatory supplemental withholding rate under the American Jobs Creation Act apply?
A-3.12. The mandatory 35 percent supplemental withholding rate established by Section 904(d) of the American Jobs Creation Act applies to supplemental wages in excess of $1 million that are paid after December 31, 2004.  The application of the mandatory 35 percent withholding depends on when the wages are deemed paid under the settlement initiative.  The fact that the taxes are paid after December 31, 2004, is not relevant if the taxes are attributable to wages paid before 2005.

Q-3.13. Under Section 3(c) of Announcement 2005-19, when options are exercised, how does the Executive report the additional compensation income and liabilities for employment taxes and penalties?
A-3.13. The Executive should submit with his future Form 1040 a copy of his Announcement 2005-19 closing agreement along with a statement showing his calculation of additional wage income, the resultant employment tax and accuracy-related penalty. Using the 2004 Form 1040 as an example, the additional wage income would be included on line 7 and the employment tax would be included on line 58. The accuracy-related penalty would not appear on the Form 1040 itself.

Q-3.14. If adjustments to the Form 941 tax returns are barred by the expiration of the period of limitations for the calendar year ending during the taxable year in which the Corporation claims the deduction, must the Executive and the Corporation still pay employment taxes in order to participate in the settlement initiative?
A-3.14. Yes

Section 4 - Procedures for Closing Cases

Q-4.1.  How do I elect to participate?  What formats are acceptable and what is required?
A-4.1.  Notice of Election forms - Form 13656 for the Executive and the Related Party, Form 13657 for the Corporation - have been created for this announcement and are available on the IRS Web site at http://www.irs.gov/businesses/corporations/article/0,,id=120633,00.html.  In addition, revenue agents will have copies of these forms.  The forms must contain original signatures and must be sent via certified mail or designated delivery service (within the meaning of § 7502(f)) to the address listed in the Announcement.  If you are currently under examination or in appeals, you should also send a copy to the revenue agent or appeals officer.  The Notice of Election must be complete (as required by Announcement 2005-19) and submitted on or before May 23, 2005.  The Notice of Election is required to be signed under penalties of perjury.

Q-4.2.  Will taxpayers be notified if they are not eligible for the settlement initiative?
A-4.2.  Yes, electing taxpayers will be informed if they are ineligible to participate in the settlement initiative.

Q-4.3.  Can I get an extension of time to file my election form?
A-4.3.  No.

Q-4.4.  Under what circumstances will the Service grant an extension to the taxpayer to submit the signed closing agreement?
A-4.4.  The announcement allows the taxpayer 30 days to submit the signed closing agreement.  Only under unusual circumstances will an extension be granted.  Any extensions granted must be approved by the revenue agent's manager.  Extensions will not be automatic and the taxpayer must explain to the satisfaction of the Service the reasons an extension is being requested.  The Service has the discretion to grant or to refuse an extension.

Q-4.5.  What are the options for a taxpayer to remit payment if they do not want to mail a check?
A-4.5.  Participants should speak with their revenue agent or revenue officer (or appeals officer, as appropriate) about electronic payment options. 

Q-4.6.  If I must make a payment of tax under the initiative for income recognized in 2004, how can I compute the amount if I haven’t filed my 2004 return yet (due to an extension)?
A-4.6.  If you cannot compute your 2004 tax within the time frames required under the Announcement, you should base your payment on the maximum marginal rate multiplied by the income recognized under the settlement initiative. If this payment, when combined with any other payments of 2004 income tax, results in an overpayment when you file your 2004 income tax return, your return will serve as a claim for refund.

Q-4.7. If a Corporation and its Executives elect to participate in the settlement initiative and, by reason of the terms of the settlement initiative, the corporation has increased employer FICA tax liability and is entitled to a refund of income tax due to increased compensation deductions, should the Corporation expect that the closing agreement will permit the taxpayer to "net" those amounts?
A-4.7. No. Corporations should expect that the closing agreement will treat their employer FICA liability and income tax refund separately.

Q-4.8. If the taxpayer can’t full pay immediately and wants to make an arrangement to pay with Collection, will it cover only the years on the Form 906?
A-4.8. If the taxpayer has liabilities for other years those years must be included in the arrangement with Collection.  If an arrangement is not reached that includes all liabilities, then the taxpayer would have to full pay the years covered by the initiative in order to participate in the settlement.

Q-4.9. What if the taxpayer has unfiled tax returns?
A-4.9. The taxpayer will not be able to reach an acceptable arrangement with Collection unless all delinquent returns have been filed.  Any liability from those returns will need to be paid or included in the arrangement to resolve the account.

Q-4.10. If the taxpayer can’t full pay immediately and requests additional time to pay the account, will they be charged penalty and interest?
A-4.10. Yes.  It is important for the taxpayer to know that penalty and interest will continue to accrue on the account until it is fully paid.  Interest is calculated on the entire unpaid liability and failure to pay penalty is calculated on the unpaid tax portion of the account.  Depending on the circumstances, other penalties may also apply.

Q-4.11. Will a Notice of Federal Tax Lien be filed if full payment is not returned with signed closing agreement?
A-4.11. Generally, a Notice of Federal Tax Lien will be filed if the liability is not full paid.  An extension of time to full pay the liability can be granted for up to 120 days.  Under these circumstances, the filing of a Notice of Federal Tax Lien can be withheld.  An extension of time will not be granted if complete financial information has not been provided.  The filing of a Notice of Federal Tax Lien can be withheld if the taxpayer posts a bond or other acceptable collateral security.  See Internal Revenue Manual 5.12.2 for further reference.

Miscellaneous

Q-Misc.1. An audit of a taxpayer is still in process for unrelated issues.  The taxpayer submitted an election to participate in the settlement initiative.  How should the revenue agent proceed?
A-Misc.1. The case should be treated as a partially agreed case and the settlement should be processed following the same time requirements under the Announcement.  A partial agreement should be obtained with appropriate modification to the closing agreement language for a partial agreement.  The taxpayer retains their Appeal rights for the unrelated issues if they are unagreed.

Q-Misc.2.  How should the revenue agent handle a joint return where one spouse elects to participate but the other spouse does not and "innocent spouse" relief is not being claimed?
A-MIsc.2.  One spouse can elect to participate even if the other spouse does not. There are Non-Masterfile procedures for dealing with this situation.  The revenue agent should seek assistance for this situation.

Q-Misc.3.  Should a copy of the announcement be sent to the taxpayer and their POA to advise them of its issuance?
A-Misc.3.  Although not a requirement, as a courtesy, the revenue agent may send a taxpayer under examination the Announcement and the Notice of Election form.  The agent may consult the Technical Advisor's website for the form letter to be issued for transmitting the Announcement and election form.  If a joint return, separate letters to each spouse are required.  If a TEFRA entity, the letter will be sent to the tax matters partner.  Copies will be sent to the POA as appropriate.  Receipt of the Announcement and Notice of Election form (or lack thereof) is not an indication of eligibility to participate in the settlement initiative.

Q-Misc.4.  Is the Notice of Election filed by the taxpayer binding on the taxpayer?
A-Misc.4.  No. The terms of the settlement are not binding until execution of the closing agreement.  The filing of the Notice of Election does not obligate or bind the taxpayer to enter into the closing agreement.

Q-Misc.5. When will the interest suspension period under section 6404(g) end for Executives who participate in the settlement initiative?
A-Misc.5 As originally enacted, section 903 of the American Jobs Creation Act  of 2004 (AJCA) removed listed transactions and undisclosed reportable transactions from eligibility for interest suspension under section 6404(g) effective for interest accruing after October 3, 2004.  Section 303 of the Gulf Zone Opportunity Act of 2005 amended the effective date of section 903 of the AJCA.  Section 903 of the AJCA now provides that for listed transactions and undisclosed reportable transaction interest is also not suspended on or before October 3, 2004, subject to several exceptions.  One exception is for taxpayers who have entered into a settlement agreement pursuant to certain settlement initiatives, including the Announcement 2005-19 settlement initiative.  To qualify for this exception, the taxpayer's closing agreement must be executed by both the taxpayer and the Internal Revenue Service by January 23, 2006.  Because the Commissioner's delegate must also sign the closing agreement by January 23, 2006, taxpayers intending to qualify for this exception must ensure that their signed closing agreements are received by the Internal Revenue Service by January 23, 2006.  A taxpayer should notify his or her revenue agent to arrange for delivery of the signed closing agreement so that it can be signed on behalf of the Commissioner by January 23, 2006.

For an electing taxpayer who does not enter into a settlement agreement by January 23, 2006, interest on Notice 2003-47 transaction will not be suspended by section 6404(g) for any period unless the taxpayer qualifies for another exception under Section 303 of the Gulf Zone Opportunity Act of 2005.

Page Last Reviewed or Updated: 19-Nov-2014