The NASPP Blog

January 13, 2009

Recent 409A Developments

There were several developments in December related to Section 409A that you should be award of; today I discuss two of them. 

Notice 2008-113: Corrections Program for Discounted Stock Options

One thing that the options backdating scandal highlighted is that few of us have blemish-free grant procedures (although hopefully we are a lot closer to that ideal now, then we were ten– or even five–years ago).  Occasionally, a snafu occurs and an option that was intended to be granted at FMV is granted at a discount.  This results in a host of legal and accounting pitfalls, not the least of which is that the option could retroactively become subject to Section 409A–forcing the optionee to exercise within a fairly limited time after the option vests or face 409A’s onerous 20% penalty tax.

Fortunately, under Notice 2008-113, the IRS has established a 409A corrections program for discounted stock options, essentially giving the company a “do-over” for option pricing glitches.  Under the corrections program, once an option is granted, the company has until the end of the calendar year to correct pricing errors for options granted to Section 16 insiders and has until the end of the calendar year following the grant to correct pricing errors for options granted to other individuals. In both cases, however, the options must be corrected before they are exercised–once an option is exercised, all bets are off and the optionee could be looking at that 20% penalty tax.

To be eligible for the corrections program, 1) the company has to take steps to ensure that the error won’t happen in the future, 2) the optionee can’t be under examination by the IRS, and 3) the grant documentation must indicate that the option price was intended to be at least 100% of the FMV at grant.

Of these three requirements, numbers 1 and 2 seem fairly straightfoward.  I hope that when a mistake like this occurs, you take steps to make sure that it doesn’t occur in the future. The notice does specify that you need to take “commercially reasonable” steps and I’m not quite sure what “commercially” means in this context, but I’m going to presume whatever normal steps you would take to prevent the error from occurring again would suffice. 

I also hope that you don’t have many, or any, employees under investigation by the IRS.  Although–now that I think about it–more than one stock plan administrator has mentioned to me that, in some years, large numbers of their employees receive notices from the IRS about not filing Schedule D for their same-day sale exercises, so making sure employees understand the tax ramifications of their stock plan transactions might be key to this requirement.

The third requirement, that the grant documentation state that the option price was intended to be at least 100% of FMV at grant is the most concerning.  I see a lot of grant agreements that have been streamlined over the years to remove the legal jargon that used to be de rigueur.  Generally, I encourage this practice, but here it could be a problem.  If your grant agreement just states the option price as a dollar value, with no qualification, and your option plan allows the grant of discounted options–it seems to me that you wouldn’t meet this requirement.  To make sure your options are eligible for the corrections program, you might want to review your plans or option agreements now to ensure that they state that options cannot have a price that is less than FMV at grant.

See the NASPP alert “409A Corrections Program for Discounted Stock Options” for more information.   

Notice 2008-115: 409A Reporting and Withholding and Calculation of Income Subject to Penalties

As mentioned in my December 17 blog, in early December the IRS issued Notice 2008-115, which suspends code Y reporting until further guidance is issued.  The notice also provides guidance on how to calculate income that is subject to penalty under 409A–which currently must be reported in boxes 1 and 12 (with code Z) of Form W-2.  I’ll write more about this calcuation in a future blog, when I discuss the proposed regs the IRS issued on this subject.

See the NASPP alert “IRS Issues Guidance on Section 409A Reporting and Withholding” for more information on Notice 2008-115 and see our alert “IRS Proposes Regulations for Calculating 409A Income and Penalty Taxes” for more information on the proposed regs.

Reason #8 to Renew Your NASPP Membership:  Year-End Procedures Portal

The NASPP’s Year-End Procedures Portal has everything you need to streamline your year-end processes, including tax and other legal updates for the year, sample employee communications, year-end reporting timelines and checklists, and FAQs on Form 1099 and Form W-2 reporting.

New NASPP Online Course on Stock Compensation and M&A

The NASPP is pleased to introduce our newest online educational program, Tackling Equity Compensation Issues Related to Mergers & Acquisitions. At only $495, this course is a true bargain–and members that register by February 6th can qualify for yet another $100 off this price. Stock plan professionals involved in any aspect of the M&A process won’t want to miss this valuable program. 

NASPP “To Do” List

We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blogs. 

– Barbara