Backdated Stock Options

IRS Offers Opportunity for Employers to Satisfy Tax Obligations of Rank-and-File Employees with ‘Backdated’ Stock Options.

The Internal Revenue Service officials announced an initiative aimed at providing relief for rank-and-file employees affected by their companies’ issuance of backdated and other mis-priced stock options.

While the program will be available to help these employees who may be unaware that they held backdated options, the opportunity will not be available for backdated options exercised by most corporate executives or other insiders.

If an employee exercised a ‘backdated’ stock option in 2006, the employee may owe an additional 20-percent tax, plus an interest tax, under the Federal tax laws governing deferred compensation. If the option had been properly priced, the employee normally would only have owed income tax on the difference between the value at the date of grant and exercise.

The initiative, described in Announcement 2007-18, allows companies to step forward and pay the additional 20-percent tax and any interest tax that employees owe. The initiative does not permit the company to pay the additional tax for stock options exercised by its top executives or other insiders.

"This shameful practice was widespread,” said IRS Commissioner Mark W. Everson. “We are allowing employers to satisfy the tax obligations of employees who did not knowingly participate in these schemes. This initiative does not extend to the executives and insiders who were the principal beneficiaries of the backdating schemes. We continue to pursue these cases and work closely with the Securities and Exchange Commission and the Justice Department as appropriate."

This initiative does not involve or affect any other federal agency’s investigations or regulatory action.

Under a 2004 law, the tax consequences associated with backdated and other mis-priced stock options issued at a discount affect most recipients who exercised their options in 2006. If these stock options were issued to the employees at a below-market price, the 2004 law requires an additional 20-percent tax and interest tax on options exercised in 2006. The law does not affect options that were earned and vested before 2005.