Stock options backdating back datedated dating option
Because the on-going possibility of securities litigation, it is important to carefully manage all responses to the IRS audit so as to avoid any waiver of the attorney-client privilege or the attorney work product privilege. Fuller, Partner, Tax Group [email protected], 650.335.7205 Scott P.
Fifty-two companies currently under criminal investigation. Moreover, the company avoids having to expense the options as current compensation, thus increasing earnings in the near term.The IRS's interest in the tax implications of backdated options is not new.We are currently working with a number of clients that have already received Information Document Requests ("IDR") from the IRS requesting information relating to the backdating issue.It is not intended, and should not be regarded, as legal advice.Readers who have particular questions about these issues should seek advice of counsel.Furthermore, the Directive states the special requirements apply regardless of whether the issue arises from error or was the result of deliberate actions.
The Directive instructs agents to identify the existence of any backdating issues at the beginning of any corporate examination. The Directive states that the backdating issue should be identified early in the audit process so as to "ensure proper statute [of limitations] procedures are in place to address this issue at the individual level." Thus, the Directive signals that the IRS intends to use its audits of corporate taxpayers as a tool for the timely identification of individuals who have benefited from backdating so that the IRS can pursue separate audits of such individuals before any relevant statute of limitations lapse.
The consequence of a discounted stock option being subject to § 409A is that the option holder recognizes taxable income as the option vests (and thereafter), whether or not the option has been exercised (in other words, whether or not the option holder has actually obtained any value from the option).
This additional taxable income will be subject to a 20% federal tax in addition to the regular tax rate, plus regular state income taxes (and possibly additional state penalty taxes). It is important to note that taxpayers generally have until December 31, 2007, to amend their discounted stock options to comply with § 409A (generally by increasing the exercise price to what was fair market value on the date the option was granted), but any pre-amendment exercise made in 2007, however, are subject to § 409A taxes.
Another consequence is that the company underrepresents the real nature of an executive’s compensation, perpetuating the myth that options are performance-based incentive compensation.
The backdating problem was first highlighted by Professor Erik Lie of the University of Iowa, who published his initial study in 2004.
On July 11 the IRS released an internal Industry Director Directive memorandum dated June 15, 2007 (the "Directive"), which designates transactions involving backdated stock options as a "Tier I Issue" for IRS agents.