The consequences of backdating executive stock options

Basically, a stock option is a contract right to purchase an amount of stock at a set price for a period of time.

For instance, if a stock was worth a share, a stock option may grant an option holder the right to purchase

Basically, a stock option is a contract right to purchase an amount of stock at a set price for a period of time.For instance, if a stock was worth $10 a share, a stock option may grant an option holder the right to purchase $1,000 shares at $10 a share for a period of 5 years.

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Basically, a stock option is a contract right to purchase an amount of stock at a set price for a period of time.

For instance, if a stock was worth $10 a share, a stock option may grant an option holder the right to purchase $1,000 shares at $10 a share for a period of 5 years.

Some companies set the grant date at the lowest point within a 30-day window ending on the actual grant date, thereby virtually guaranteeing a below market price option.

In other situations, when a company believes its stock would dramatically increase in value based on a future event, options are granted just prior to the favorable event. Another type of backdating occurs when the company will announce bad news that could temporarily depress its stock price.

In some cases, the date of exercise, rather than the date of grant, was changed to an earlier date to convert ordinary income into capital gains.

,000 shares at a share for a period of 5 years.

Some companies set the grant date at the lowest point within a 30-day window ending on the actual grant date, thereby virtually guaranteeing a below market price option.

In other situations, when a company believes its stock would dramatically increase in value based on a future event, options are granted just prior to the favorable event. Another type of backdating occurs when the company will announce bad news that could temporarily depress its stock price.

In some cases, the date of exercise, rather than the date of grant, was changed to an earlier date to convert ordinary income into capital gains.

If the stock dropped below /share, the stock would be "under water"; therefore, the option would not be exercised, since the stock price is lower than the cost of exercising the option.

There are two potential tax advantages in this scheme: First, the earlier the date of exercise, the sooner the 12-month period will be reached for the favorable 15% long-term capital gains rate.

In addition, by choosing an exercise date in which the stock had a low value, the executive converts potential ordinary income into capital gains.

IRS intends the program to minimize compliance burdens on employees who are not corporate insiders while collecting the additional taxes due.

Under the IRS initiative, employers will not report the additional taxes on the employee's W-2 and the employee will not be obligated to pay the additional taxes.

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In-the-money options, however, violate the ISO rules under IRC Sec.

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