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.In particular, California takes the position that its tax code imposes a parallel tax to that imposed by § 409A, with the result that the income deemed recognized may be taxed at an aggregate rate (U. With respect to options granted to certain executives subject to the disclosure requirements of Section 16(a) of the Securities Exchange Act of 1934, the transition relief to cure disqualified options was only available through December 31, 2006.
Backdating employee stock options tax implications
Designated as a Tier I Issue, IRS field agents are now required to audit all transactions involving backdated stock option grants and/or backdated exercise prices.
The Directive also expands the categories of options that trigger special attention to include any options that might be discounted, mis-priced, mis-dated, or in-the-money.
There are three principal tax issues associated with the backdating issue.
Each of these three issues is identified and discussed briefly in the Directive.
Backdating of an option may prevent it from qualifying for the exception set forth in Treas. Backdating of a stock option might prevent such option from qualifying as an ISO as § 422(b)(4) requires that the option's exercise price be not less than the fair market value of the stock at the time such option was granted.