Employee Stock Options Not Subject to Taxation at Local Level

The Commonwealth Court recently ruled that stock options provided by employers to their employees are not considered "earned income" subject to the wage tax imposed by most local taxing authorities in Pennsylvania. In Marchlen v. Township of Mt. Lebanon, the court reviewed the stock option program offered by ALCOA to certain key employees, including Louis Marchlen, the company's general counsel. Mt. Lebanon Township claimed that the difference between the value of ALCOA's stock at the time the options were offered to Mr. Marchlen and the price he actually paid under the plan when exercising the stock options should be considered compensation subject to the earned income tax imposed under the Local Tax Enabling Act (LTEA).

In support of its position, the township relied on rules and regulations promulgated by the IRS for federal tax purposes and by the Pennsylvania Department of Revenue for state personal income tax purposes. In rejecting the township's position, the court explained that the definition of the term "earned income" is explicit in the LTEA and cannot be expanded by the township in its ordinance or regulations. For the same reason, the court found that the township's reliance on case law or rules applicable for federal and state income tax purposes was misplaced. The court arrived at its conclusion even though ALCOA required employees to wait at least one year before exercising stock options and to remain with ALCOA for one year after being awarded the options. The court also recognized that the township would not be able to tax the gain on the sale of the stock by Mr. Marchlen because that too would not be "earned income."

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