Tax Alert: IRS Still Seriously Looking For Backdated Stock Options (July 2007)
The IRS continues to hunt for backdated stock options, with implications for employees at companies that backdated them (even if options were only accidentally mispriced or misdated).
In mid-July the IRS released an internal Industry Director Directive on backdated options (the document is dated June 15, 2007), making this a "Tier I" issue for IRS field agents. The memorandum shows the importance that the IRS, in its tax audits of companies and individuals, is placing on the topic of backdating.
This brief document (highly readable for the IRS) highlights a few of the tax issues the IRS will focus on:
- ISOs that are masquerading as NQSOs because the options were granted at less than the fair market value on the grant date, even if this was a mistake you weren't aware of at grant or at exercise
- discounted stock options that trigger extra taxes and penalties under Section 409A of the tax code
- options that no longer fit into the "qualified performance-based compensation" exception to the $1 million deduction limit for compensation paid to the CEO and the other very highly paid executives under Internal Revenue Code Section 162(m)
In the checklist attached to the directive, the IRS says that in audits it wants your company to provide details of any backdated options you may have exercised.
For details about the impact of backdating on rank-and-file employees, and the related taxation, see the relevant FAQ on myStockOptions.com and another tax alert we sent earlier this year.
Editor's Update: On April 22, 2008, the IRS issued a directive that redesignated the status of backdated stock options from Tier I to Tier II, indicating a less intensive focus on the issue by the IRS.