Section of Taxation Publications
  VOL. 53
NO. 3
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
 Capital Gain v. Ordinary Income and the FICA Tax Treatment of Employee Stock Purchase Plans
Kevin Wiggins*

* Associate, Haynes & Boone, Dallas, Texas. University of North Florida, B.A., 1992; Cornell University, J.D., 1996.


On July 2, 1999, the Service dropped a bombshell on sponsors of employee stock purchase plans ("ESPPs") with the issuance of Field Service Advice 1999-26034 ("FSA"). 1 The FSA dramatically changes how amounts received under an ESPP should be treated for purposes of the Federal Insurance Contributions Act ("FICA"). The FSA concludes in part that the amount by which the fair market value of the ESPP stock on the exercise date exceeds the option price is wages under FICA at the time of the exercise of the ESPP option. 2 Prior to this release, the consensus was that these amounts were not subject to FICA at all.

At the heart of the issue is the distinction drawn by Congress between items of income characterized as ordinary income and those characterized as capital gain; a distinction that implicates many aspects of taxation. Now the distinction enters the fray of FICA taxation of ESPPs. Even the Service recognizes the importance of the ordinary income/capital gain dichotomy in section 13 of the FSA where it declares that compensatory amounts, but not proprietary amounts, are subject to FICA. 3

This Article reviews the statutory language governing ESPPs and FICA as well as the legislative history of ESPPs and the relevant case law interpreting FICA, characterizes each element of income derived from an ESPP, and identifies each element’s proper treatment under FICA. It will be shown that contrary to the Service’s position in the FSA, there are three, not two, elements of income: the "employer-provided discount," the "Option Gains," and the "Stock Gains." Each of these elements is discussed more fully in Part II, which provides a brief overview of ESPPs. Part III analyzes the FICA and its applicable case law. Two theories emerge that potentially support the proposition that the Option Gains are not subject to FICA. Part IV summarizes the taxation of stock options in general. Part V reviews the legislative history of ESPPs as well as the historical and current taxation of stock options to identify the proper characterization of each element of income derived from an ESPP option. Part VI applies the two theories developed in Part III to the findings set forth in Part V and concludes that only the employer-provided discount (or, if lower, the excess of the fair market value of the stock at the time of the disposition or the employee’s death over the exercise price) should be subject to FICA.



1 F.S.A. 1999-26-034 (Jul. 2, 1999), 1999 FSA LEXIS 77. [Back to text.]

2 See id. [Back to text.]

3 See id. at *13. [Back to text.]


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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