To the extent that backdated stock options were erroneously included as a deductible performance-based compensation expense, corporate taxable income may be significantly underreported. The IRC section m limitation was established in to discourage excessive executive compensation. Since , the portion of executive compensation attributable to stock options has increased dramatically. Not surprisingly, many attribute the popularity of stock options to the passage of section m.
Changes in the tax law may not be the entire reason, however. In , FASB backed off on a proposal to require stock option disclosures. And in , FASB was forced to rescind a decision that would have required all stock options to be expensed after Congress threatened to take over financial standards-setting if FASB required the expensing of stock options. The continuing favorable accounting treatment may have also contributed to the growth in stock options. Stock option plans can generally be classified into two categories: NSO grants are generally nontaxable events.
Upon exercise, an employee recognizes ordinary income for the difference between the stock value and the exercise price. This income is employment compensation, which requires income and FICA tax withholding. No corporate tax consequences exist when employees dispose of stock acquired from NSOs.
Perversely, and purely from a tax perspective, backdating increases corporate deductions and the benefits that may be available as compared to the deductions available at the actual grant date.
Options backdating - Wikipedia
The artificial difference between the exercise price and the stock value from backdating provides a larger—albeit fraudulent—employment compensation deduction [subject to IRC section m ]. Examples of such NSOs are those composed of exchange-traded options. In these cases, employees must recognize any discounted option value as ordinary income upon grant, rather than upon exercise.
Upon exercise, no additional income or deductions are recognized. If discounted options with a readily ascertainable fair market value are backdated to a date when the FMV was lower, employees would understate their compensation in the year of grant. For such NSOs, corporations may again have forgone compensation deductions [subject to IRC section m limitations] due to backdating. Upon the disposition of the stock, the employee would have an incorrect basis, which would allow an overstatement of income taxed at favorable capital gain rates. While GAAP standards focus on whether an option is in-, at-, or out-of-the-money, the tax standards related to NSOs make no such distinction.
However, rank-and-file employees may also be knowingly or unknowingly affected by backdated ISOs. ISOs are the most common form of qualified stock options. ISOs provide employees with favorable tax treatment because employees do not recognize income on the grant date or on the exercise date unless the employee breaks the ISO rules.
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The ISO bargain element is recognized only upon the sale of the stock. The gain is classified as a capital gain, which typically has a lower tax rate than ordinary income.
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- Backdating of Executive Stock Options.
- Option Period Vs Fixed Date Forward Contracts: Explained - www.hiphopenation.com.
Upon exercise, the corporation would receive a deduction related to the NSO, as discussed above. Correcting a backdated ISO may provide additional corporate tax deductions on amended returns. Employees affected by backdating would owe ordinary income taxes and FICA in the year the option is exercised.
In addition, the treatment of the stock disposition would also be incorrect for backdated ISOs. IRC section A dramatically changed the tax treatment of in-the-money stock options. Section A requires that the FMV of all in-the-money employee stock options be recognized as income at the time of vesting, rather than upon exercise. For in-the-money stock options, this generally means that affected employees must recognize ordinary income for the difference between the stock price on the measurement date and the option strike price as vesting occurs.
Section A will accelerate income recognition from the exercise date to the vesting date. Some companies have agreed to pay these taxes on behalf of their affected employees. For Permissions, please e-mail: You do not currently have access to this article. You could not be signed in. Sign In Forgot password? Don't have an account? Sign in via your Institution Sign in. Purchase Subscription prices and ordering Short-term Access To purchase short term access, please sign in to your Oxford Academic account above. This article is also available for rental through DeepDyve.
Option Period Vs Fixed Date Forward Contracts: Explained
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