What are the individual's tax implications when exericising stock options if the company doesn't take the deduction it's entitled to?

Are the options ISOs or NQSOs? I assume that they are NQSOs since the employer is not entitled to a deduction on the employee's exercise of an ISO. If the employee is vested in the options at exercise, the employer is entitled to an immediate deduction, equal to the amount includible in the employee's ordinary income (FMV at exercise less exercise price). If the employee isn't vested, then the amount is deductible in the taxable year that the options vest, or, if earlier, the year that the employee makes an 83(B) election. NQSO withholding requirements include reporting the ordinary income amount on the employee's W-2 as wages, subject to supplemental compensation withholding rates (28% for federal) and FICA/FUTA also applies. While withholding, however, is not required if the optionee is a director or independent contractor, the amount must be reported on 1099-Misc. An employer that fails to timely report these amounts is subject to delinquent information return penalties, and the deduction on the corporate return lacks support. The failure of the employer to claim the amount includible in the employee's gross income as a compensation expense deduction has no implications regarding the tax treatment of the option on exercise, or the subsequent disposition of the stock. The employer that properly reported the income, but failed to claim the deduction, should consider amending its return.

The simple answer is that the person exercising the stock option must recognize income, whether or not the corporation takes the deduction.