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Stock option backdating has erupted into a major corporate scandal, involving potentially hundreds of publicly-held companies, and may even ensnare Apple's icon, Steve Jobs.
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.
The amount subject to the additional 20% penalty tax could be any of the following: It is also possible that the tax could be determined as of the date of grant and then additional tax imposed if the option value increased on the later vesting dates.
Furthermore, any individual at the company who knowingly failed to withhold or pay income tax or FICA could be subject to personal liability for any such failure.
Depending on the number of affected options and the degree to which those options have been exercised, the liability for underpayment of employee withholding taxes could be substantial.
In this case, the company may have to amend its income tax returns and could be subject to interest and penalties for any additional income tax it owes.
Footnotes: 1: Aside from Code Section 409A, deeply discounted stock options, that is options that are granted with an exercise price that is less than 25% of fair market value of stock on the date of grant, may be treated by the IRS as restricted stock and taxable to the recipient to the extent vested.If the exercise price of a discounted option is increased to the fair market value of the stock on the original grant date of the option (see paragraph (1) above), and the company decides to compensate the option holder in 2006 for the lost economic benefit resulting from such increase in the option’s exercise price, the cash or stock bonus must be subjected to a vesting schedule.