Stock Option Question

[Guest cac1134]

A non-qualified stock option granted in 2007 is exercisable in the 12 month period after January 1, 2010. If optionee terminates employment before 1/1/2010, option expires. If optionee dies before 1/1/2010, executor has the 12 months to exercise. Will this design pass muster as "not having any element of deferal" and therefore 409A exempt? What say you all?

[namealreadyinuse]

Is it otherwise eligible for the exception (common stock, FMV, etc.)?

You are describing the design of 90% of options out there: vesting on a future schedule (in 2010 or on death) and exercisable for a period after vesting (12 months).

What am I missing that is controversial?

[Guest cac1134]

nothing controversial ... i was going in circles until this occurred to me and it is so simple i thought there might be something amiss. thanks for answering. also, the period can be 14 1/2 months after 1/1 due to short term exception.

[namealreadyinuse]

There is no need for the short-term deferral rule if you are already outside of 409A. Let them be exercisable for 20 years . . .

[Guest Harry O]

If all these terms are built in to the option agreement at grant and you meet the other requirements of the exception for stock options (e.g., no discount), you should be totally exempt from 409A. You don't need to worry about the short term deferral exemption . . .

[Guest cac1134]

this takes me right back to the question i raised in a different thread, namely, is the option in compliance with 409A or exempt from 409A and may i safely conclude it doesn't matter?

[Steelerfan]

this takes me right back to the question i raised in a different thread, namely, is the option in compliance with 409A or exempt from 409A and may i safely conclude it doesn't matter?

For most purposes it won't matter, but . . .

. . . I believe the IRS is taking the position that NQSO that meet the definition in the regulations are merely in compliance with 409A. This will allow them to "go after" accidentally mispriced options as being in violation (e.g options that were accidentally discounted due to a faulty grant). This position is clearly not a certain one, and it has little or no statutory support.

My prediction is that when litigated, the courts will decide that nonqualified stock options granted at FMV are exempt from 409A. If that turns out to be the case, then everyone who accidentally mispriced their options due to "not so great" grant procedures or other administrative snafoos (NOT intentional backdaters), and who assume they violated 409A will be sorry if they pay the excise tax under 409A pusuant to the new announcement 2007-18.

[Just Me]

The IRS's position is that if a NQSO has an exercise price that, at all times, is at least as great as the fair market value of the underlying stock on the grant date, and there are no additional deferral features, is is exempt from Section 409A (not just merely compliant with Section 409A.)

Here is an excerpt from the (soon to be finalized) proposed regulations on this point:

"The legislative history states that section 409A does not cover grants of stock options where the exercise price can never be less than the fair market value of the underlying stock at the date of grant (a non-discounted option). See H.R. Conf. Rept. No. 108-755, at 735 (2004). Thus an option with an exercise price that is or may be below the fair market value of the underlying stock at the date of grant (a discounted option) is subject to the requirements of section 409A. Consistent with the legislative history and with Notice 2005-1, Q&A-4, these regulations provide that a non-discounted stock option, that has no other feature for the deferral of compensation, generally is not covered by section 409A. However, a stock option granted with an exercise price below the fair market value of the underlying shares of stock on the date of grant generally would be subject to section 409A except to the extent the terms of the option only permit exercise of the option during the short-term deferral period."

Section 409A and most of the related guidance was developed before stock option backdating hit the fan.

[Steelerfan]

You kind of helped proved my point. Your statement quoted from the notice-- "these regulations provide that a non-discounted stock option, that has no other feature for the deferral of compensation, generally is not covered by section 409A"

Announcement 2007-18 contains similar language on page 3. ". . . a stock option granted with an exercise price that can never be less than the fair market value of the underlying stock on the date of grant, and that does not include any additional deferral feature, generally is not subject to 409A (emphasis added).

Pursuant to the legislative history, at the money options should be exempt from 409A, you won't get an argument from me. But the addition of the word "generally" in IRS guidance (noticeably absent from language in the leg hist) leaves the door open for them to try and have their cake and eat it to. There is virtually no tax-related guidance on when a NQSO is officially "granted" for puposes of taxation. 409A does not answer this question. There are many stock option plans out there that by their terms are prohibited from granting discounted options, yet because of imprecise grant procedures, arguments can be made from ten different angles on whether or not the result is a "discounted" option for tax purposes. The IRS will use this uncertainty to argue that when a NQSO fails to comply with some rule that is unrelated to 409A that 409A is somehow implicated and everyone should fix their options or pay the excise tax. Bunk!

[Guest Harry O]

SF -

I understand your frustration with the IRS program. However, if your client announced a "backdating" restatement, they can expect a quick visit from their friendly IRS auditor. There is definitely a different standard for determining the "measurement date" for accounting purposes and the "grant date" for tax purposes. That said, it will be guerilla warfare with the IRS on a grant-by-grant basis. And the outcome not only effects the grants that were already exercised but it also effects unexercised grants held by employees. Some employers have just decided to stop the madness and enter the program just to let their employees sleep at night.

I don't dispute your general point but most companies are not inclined to fight this trench warfare for the next few years at the expense of their employees. Employers don't want any tax uncertainties around what they pay their employees (other than perhaps very senior management).

Harry O (BTW, that wasn't pass interference on Benny Barnes in SB XIII!!!!)

[Steelerfan]

HarryO:

That's true, if a restatement were necessary, I definitely wouldn't push it. In fact, despite what I think the law is (or should be interpreted), I might recommend repricing options just to make a potential problem go away. However, option agreements are contracts, as well as SEC regulated, and a tender offer may be required to reprice--which can be expensive and time consuming. All that trouble before anyone knows what the heck the law really requires!

BTW--Lynn was falling all over the place, how could it not have been interference? Besides, Jackie should have caught that TD pass!