IRS Raises Doubts about Travelers Stock Option/401(k) Plan

The plan by Travelers Group to contribute stock options to its 401(k) plan is getting another look from the IRS. The IRS had initially given the first-of-its kind plan a favorable private letter ruling, but it now is reexamining the issue. Under the Travelers plan, the company would contribute stock options with a value equal to 10% of pay into employee 401(k) accounts each year. Pay over $40,000 would be ignored, however. The options would vest immediately, but could only be exercised 20% per year. Employees could only exercise the options if they remained employed. Unexercised options would lapse. Travelers would take a deduction on the contribution equal to a computed fair market value of the options at the time they were contributed.

The IRS came under considerable pressure from companies that provide options to employees to reverse the ruling. The companies were concerned that Travelers would want to value the options at as high a price as possible in order to maximize the deduction. That could put pressure on other option-granting companies to value their options at a higher price, something that would show up in a footnote on their income statement and possibly hurt shareholder perceptions of their earnings. At the same time, it appears some people in the IRS were concerned about the fact that Travelers was taking a deduction for options that might ultimately never be exercised. A ruling is expected in the next few months. The Travelers plan generated considerable interest, but companies now will have to wait for the IRS response.