The IRS has issued a directive identifying backdated stock options as a Tier 1 Compliance Issue. The directive explains the tax implications of backdated options, including the fact that options backdated to produce a “build-in” profit do not qualify as incentive stock options (ISOs). Corporations that intended backdated options to qualify as ISOs may be required to withhold and pay income and employment taxes when the option is exercised, and the individual may owe additional taxes at the time of exercise. As the directive explains, there are also 162(m) and 409A issues.
The designation of option backdating as a Tier 1 Compliance Issue means it is a mandatory examination item for taxpayers with backdated stock option grant and/or exercise prices.