Consequences of backdating stock options


17-Feb-2015 09:08

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Therefore, Acme may not deduct Mike’s compensation in excess of the

Therefore, Acme may not deduct Mike’s compensation in excess of the $1,000,000 salary, which could cause a restatement of earnings of $10,000,000. 409A, was enacted after the Enron scandal and targets deferred compensation schemes, including in-the-money options granted before October, 2004 and vesting after December 31, 2004. 409A applies, Mike is taxed on the spread ($10,000,000) at the time his stock options vest, not when he exercises them. 409A triggers a 20% excise tax penalty in addition to the immediate income tax, plus interest (currently about 9% per annum, plus a 1% per year interest penalty) and potentially an accuracy-related penalty of an additional 20%!Also, Mike has ordinary income on the date the options are exercised and could be subject to much harsher rules under IRC Sec.409A instead (discussed below). In our example, Mike’s options vested immediately, so he owed $10,000,000 in ordinary income on the date he received the stock grant. Under the IRS initiative, employers will not report the additional taxes on the employee’s W-2 and the employee will not be obligated to pay the additional taxes.Variations of Backdating Options Unlike the abusive corporate tax shelter ploys which often involve complex manipulation of a transaction to achieve tax results that are inconsistent with the economic reality of the deal, stock option backdating is a relatively crude device: A corporation merely changes the date that a stock option was actually granted to an earlier time when the stock price was lower.Thus, the option becomes “in the money”, meaning there was a built-in profit on the underlying stock, on the grant date.

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Therefore, Acme may not deduct Mike’s compensation in excess of the $1,000,000 salary, which could cause a restatement of earnings of $10,000,000. 409A, was enacted after the Enron scandal and targets deferred compensation schemes, including in-the-money options granted before October, 2004 and vesting after December 31, 2004. 409A applies, Mike is taxed on the spread ($10,000,000) at the time his stock options vest, not when he exercises them. 409A triggers a 20% excise tax penalty in addition to the immediate income tax, plus interest (currently about 9% per annum, plus a 1% per year interest penalty) and potentially an accuracy-related penalty of an additional 20%!

Also, Mike has ordinary income on the date the options are exercised and could be subject to much harsher rules under IRC Sec.409A instead (discussed below). In our example, Mike’s options vested immediately, so he owed $10,000,000 in ordinary income on the date he received the stock grant. Under the IRS initiative, employers will not report the additional taxes on the employee’s W-2 and the employee will not be obligated to pay the additional taxes.

Variations of Backdating Options Unlike the abusive corporate tax shelter ploys which often involve complex manipulation of a transaction to achieve tax results that are inconsistent with the economic reality of the deal, stock option backdating is a relatively crude device: A corporation merely changes the date that a stock option was actually granted to an earlier time when the stock price was lower.

Thus, the option becomes “in the money”, meaning there was a built-in profit on the underlying stock, on the grant date.

Expect IRS to aggressively pursue this cheating since it amounts to tax fraud and evasion, pure and simple, and is relatively easy to prove.

Stock options are promoted by their supporters as the most effective way to align executive and employee interests with those of shareholders.

The company waits until the stock drops, then issues the options at a low point in the stock’s price.

,000,000 salary, which could cause a restatement of earnings of ,000,000. 409A, was enacted after the Enron scandal and targets deferred compensation schemes, including in-the-money options granted before October, 2004 and vesting after December 31, 2004. 409A applies, Mike is taxed on the spread (,000,000) at the time his stock options vest, not when he exercises them. 409A triggers a 20% excise tax penalty in addition to the immediate income tax, plus interest (currently about 9% per annum, plus a 1% per year interest penalty) and potentially an accuracy-related penalty of an additional 20%!

Also, Mike has ordinary income on the date the options are exercised and could be subject to much harsher rules under IRC Sec.409A instead (discussed below). In our example, Mike’s options vested immediately, so he owed ,000,000 in ordinary income on the date he received the stock grant. Under the IRS initiative, employers will not report the additional taxes on the employee’s W-2 and the employee will not be obligated to pay the additional taxes.

Variations of Backdating Options Unlike the abusive corporate tax shelter ploys which often involve complex manipulation of a transaction to achieve tax results that are inconsistent with the economic reality of the deal, stock option backdating is a relatively crude device: A corporation merely changes the date that a stock option was actually granted to an earlier time when the stock price was lower.

Thus, the option becomes “in the money”, meaning there was a built-in profit on the underlying stock, on the grant date.

Expect IRS to aggressively pursue this cheating since it amounts to tax fraud and evasion, pure and simple, and is relatively easy to prove.

Stock options are promoted by their supporters as the most effective way to align executive and employee interests with those of shareholders.

The company waits until the stock drops, then issues the options at a low point in the stock’s price.

consequences of backdating stock options-57

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Mike will have ,000,000 of ordinary income on the date of exercise (100,000 x the spread of /share).In-the-money options, however, violate the ISO rules under IRC Sec.