409a backdating

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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.

SEC Chairman Christopher Cox recently stated that the proposed SEC rules on disclosure of executive compensation will “almost certainly address options backdating explicitly.” I. Companies have considerable discretion in determining the timing of stock option awards.

Most employee stock options are, or purport to be, granted “at-the-money,” meaning that the exercise price of the option equals the market price of the underlying stock on the date of the grant.

While the focus of the Securities and Exchange Commission ("SEC") centers on improper accounting practices and disclosures, thereby violating securities laws, a major yet little explored consequence to the scandal involves potentially onerous taxes on those who received these options.This typically will result in adverse tax consequences for the option recipient and a tax withholding responsibility for the company.The tax consequences include taxation at the time of option vesting rather than the date of exercise or sale of the common stock, a 20% additional federal tax on the optionee in addition to regular income and employment taxes, potential state taxes (such as the California 20% tax) and a potential interest charge.Several companies have expressed their intent to restate financial statements due to option timing issues, and opportunistic attorneys have already filed derivative and class action lawsuits.The author of the academic study who is credited with focusing regulators on this issue estimates that at least 10% of “at-the-money” grants of options to CEOs between 19—before Sarbanes-Oxley shortened the reporting period for option grants—were backdated.Background On April 10, 2007, the Internal Revenue Service (IRS) issued final regulations under Section 409A of the Internal Revenue Code.

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