Discounted stock option triggers section 409A income and additional tax
Apply this to your situation
This page covers one taxpayer's ruling from 2015, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.
Plain-English summary
The IRS advised on the grant date, valuation, and tax consequences of a nonstatutory stock option. The grant date was the date the corporation completed the conditions necessary to create the option, rather than the earlier date when the parties entered into the agreement. Trading on a when-issued over-the-counter market qualified as trading on an established securities market and supplied actual transaction prices for valuing the underlying stock. Because the exercise price was below fair market value on the grant date and the option lacked permissible payment events, the option failed section 409A. For the year under examination, vested unexercised spreads and the applicable exercised amount were includible in income and subject to the additional 20 percent tax, while calculation of the premium interest tax was left for separate advice.
Ruling snapshot
- Question: How should the option's grant date, fair market value, section 409A failure, and resulting income and additional taxes be determined?
- Outcome: Advice given, the discounted option failed section 409A and generated income inclusion and additional taxes.
- Key authorities: IRC §§ 83, 409A, 6601, and 6621; Treas. Reg. §§ 1.409A-1, 1.424-1, 1.83-7, 1.280G-1, and 1.897-1; Prop. Treas. Reg. § 1.409A-4
Full text (IRS public release)
Office of Chief Counsel
Internal Revenue Service
memorandum
Number: 201521013
Release Date: 5/22/2015
CC:TEGE:EB:EC
POSTU-107896-14
UILC: 409A.00-00, 409A.01-00
date: December 18, 2014
to: Associate Area Counsel
------------------------------------------
from: Executive Compensation Branch, Tax Exempt & Government Entities
subject: Tax Matter
This Chief Counsel Advice responds to your request for assistance. This advice may not be used
or cited as precedent.
LEGEND
Taxpayer = -----------------------
Parent = -----------------------------------------------
Plan = ----------------------------------------------------------------------------
Option Shares = ----------------------------------------------------------------------------
Exercise Price = ---------
Dividend = ---------------------
Adjusted Exercise Price = ---------
Day 1 = ------------------
Day 2 = ------------------
Day 3 (--------------- Date) = ------------------
POSTU-107896-14 2
Day 1 Lowest Price = ---------
Day 2 Lowest Price = ---------
Day 3 Lowest Price = ---------
Year 1 = ------
Year 2 = ------
Year 3 = ------
Year 1 Closing Price = --------------------------------------
Year 2 Closing Price = --------------------------------------
Year 3 Closing Price = --------------------------------------
Year 2 Exercised Shares = --------------------
Year 3 Exercised Shares = --------------------
Unadjusted Shares = -------------
Adjusted Shares = -------------
Unexercised Unadjusted Shares = -------------
Unexercised Unadjusted Spread = ---------------------------------
Unexercised Unadjusted Amount = --------------------------------------------------
Unexercised Adjusted Shares = -------------
Unexercised Adjusted Spread = ---------------------------------
Unexercised Adjusted Amount = --------------------------------------------------
Exercised Unadjusted Amount = -------------------------------------------------------------------------
-------------------------------------------
Total Deferred Amount = -----------------------------------------------------------------------------------
----------------------
20% Tax Amount = --------------------
POSTU-107896-14 3
ISSUES
-
What is the grant date of the taxpayer’s nonstatutory stock option for purposes of
section 409A of the Internal Revenue Code (Code) if, under the circumstances
described below, the option agreement was entered into prior to --------------------------
---------------, subject to additional corporate action, and effective -----------? -
Is stock traded on a when-issued, over-the-counter market readily tradable on an
established securities market for purposes of determining the fair market value of
service recipient stock underlying a nonstatutory stock option that is intended to be
exempt from section 409A? -
How is the amount of the income inclusion, additional 20% income tax, and
additional interest income tax under section 409A(a)(1) calculated due to the failure
of the taxpayer’s nonstatutory stock option to meet the requirements of section
409A(a) under the circumstances described below?
CONCLUSIONS
-
The grant date of the taxpayer’s nonstatutory stock option for purposes of section
409A is the date on which the conditions for grant of the option were completed,
which was -----------------------------. -
Stock traded on a when-issued, over-the-counter market is readily tradable on an
established securities market for purposes of determining the fair market value of
service recipient stock underlying a nonstatutory stock option. For the option to be
exempt from section 409A, the exercise price may not be less than the fair market
value of the underlying stock on the grant date of the option, determined based on a
reasonable method using actual when-issued transactions in the stock reported by
the over-the-counter market. The taxpayer’s nonstatutory stock option failed to meet
the requirements of section 409A(a) because the exercise price was less than the
applicable fair market value of the underlying stock on the grant date and the terms
of the option did not provide for exercise dates that were permissible payment
events. -
The proposed section 409A income inclusion regulations set forth a methodology for
calculating the amount of the income inclusion, additional 20% income tax, and
additional interest income tax under section 409A(a)(1) on which taxpayers may rely.
Those methods for calculating the amount of the income inclusion and the additional
20% income tax are described below. Because calculation of the additional interest
income tax must take account of the taxpayer’s other tax attributes for the applicable
taxable years, advice on calculation of the additional interest income tax will be
provided separately.
POSTU-107896-14 4
FACTS
--------------------------------------------------------------------------------------------------------------
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Prior to ---------------------Date, Parent agreed to grant Taxpayer a certain number of
restricted shares of Parent’s ---------- common stock and a nonstatutory option (the
Option) to purchase a certain number of shares (Option Shares) of the ---------- common
stock. Also prior to ---------------------Date, Parent and Taxpayer executed ---------------
restricted stock agreement and --------------- option agreement providing for grant of the
restricted stock and the Option under the terms of the Plan. --------------------- the Plan, --
------- provides for awards of (or based on) Parent’s ---------- common stock. The
agreements provide that the grant date of the restricted stock and the Option is -----------
--------------- Date and that the grants are effective on ---------------------Date. The Plan,
which was drafted prior to ---------------------Date, provides that the Plan is effective on ---
-------------------- Date.
The option agreement provides that the Exercise Price is the exercise price per
Option Share.
--------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------.
The -------------- provides that Parent’s ---------- common stock would be issued on --
---- Date, subject to any necessary corporate action.
By written resolution dated one day prior to ---------------------Date, Parent’s ------------
------------------------ approved ------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------- to
grant the restricted stock and the Option. -------------------------------------------------------------
-------------------------------------------------. The resolution provides that the Plan, the
restricted stock agreement, and the option agreement (recognized to have already been
entered into) would be effective on ---------------------Date and that the Exercise Price
would be the exercise price per Option Share.
POSTU-107896-14 5
--------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-------------------------------------------------.
On Day 1, two days prior to ---------------------Date, Parent’s ---------- common stock
began trading on an over-the-counter market. -------------------------------------------------------
-------------------------------------, trades made on Day 1, Day 2, and Day 3 (----------------------
Date) were on a “when, as and if issued” (commonly called a “when issued”) basis.
--------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
----------------------------------.
The lowest when-issued trading price for Day 1, Day 2, and Day 3 (Day 1 Lowest
Price, Day 2 Lowest Price, and Day 3 Lowest Price) was at least $-- more than the
Exercise Price. On -------------------- Date (Day 3), the lowest when-issued trading price
was over $------ more than the Exercise Price.
The Plan provides that the fair market value of a share of Parent’s ---------- common
stock shall be determined, as of a particular valuation date, by the closing price per
share on such date reported by the securities exchange on which the stock is listed.
But if the stock is not listed on a securities exchange but is still publicly traded, the Plan
provides that the fair market value shall be determined, as of a particular valuation date,
by ------------------------ on such date reported by an over-the-counter bulletin board. ------
-------------------------------------------------------------------------------------------------------. If the ----
---------- common stock is not publicly traded, the Plan provides that the fair market
value shall be determined by Parent’s--------------------.
The option agreement provides that the exercise price per Option Share is the
Exercise Price. The Plan and the option agreement are the only documents setting
forth the terms of the Option. Neither the Plan nor the option agreement provides for
POSTU-107896-14 6
any other method to determine the exercise price per Option Share based on publicly
traded prices of Parent’s ---------- common stock.
The consideration for the grant of the Option was Taxpayer’s provision of future
services to Parent. Taxpayer was not required to pay any additional amount in
exchange for grant of the Option.
Under the terms of the option agreement, ---- of the Option Shares would vest
during Year 1 -------------- following the grant date, and an additional ---- of the Option
Shares would vest on the next ----- anniversaries of -------------------------- ---------------------
---------------------------------------------. The option agreement further provides that the
vested Option Shares could be exercised at any time from the vesting date until the -----
---------------.
--------------------------------------------------------------------------------------------------------------
Prior to the end of Year 3, Parent declared a dividend per share (Dividend) to be
paid to holders of its -------- common stock. For purposes of this advice, it is assumed
that, under the circumstances, the Dividend qualifies as a distribution under §1.424-
1(a)(3)(ii) and therefore as a corporate transaction for purposes of §1.409A-
1(b)(5)(v)(D).
----------------------------------------------------------------------------------------, Parent -----------
--------- determined to adjust the portion of the Option that was unvested as of the
dividend declaration date by reducing the exercise price per unvested Option Share by
the amount of the Dividend. The Adjusted Exercise Price accordingly became the new
exercise price per unvested Option Share (Adjusted Share).
--------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------the
Exercise Price remained the exercise price per Unadjusted Share.
Taxpayer is under exam for Year 3. For purposes of this advice, the statute of
limitations on assessments is assumed to have expired for Year 1 and Year 2. By the
end of Year 3, all of the Unadjusted Shares (---- of the original Option Shares) had
vested, and Taxpayer had partially exercised the Option to purchase ----- of the
Unadjusted Shares (---- of the original Option Shares), with ----- of the Unadjusted
Shares (---- of the original Option Shares) remaining unpurchased. Some of the
Unadjusted Shares (Year 2 Exercised Shares) were purchased during Year 2, and
some (Year 3 Exercised Shares) were purchased during Year 3. By the end of Year 3, -
---- of the Adjusted Shares (---- of the original Option Shares) had vested.
POSTU-107896-14 7
SUMMARY OF TAX CONSEQUENCES
The following is a summary of the tax consequences for Year 3 due to the failure
of the Option to meet the requirements of section 409A for Year 3, as described in the
following section of this advice, applicable to each tranche of the Option (based on
either vesting or purchase). The additional 20% income tax under section
409A(a)(1)(B)(i)(II) for Year 3 (20% Tax) is calculated as the product of .20 and the
amount of the section 409A(a)(1)(A)(i) income inclusion for Year 3. Because calculation
of the additional interest income tax under section 409A(a)(1)(B)(i)(I) for Year 3 (Interest
Tax) must take account of Taxpayer’s other tax attributes for Year 1 and Year 2, advice
on calculation of the tax will be provided separately.
Section 409A(a)(1)(A)(i) 20% Interest
Option Tranche_ Income Inclusion_ Tax Tax_
Shares Vested in Year 1 N/A (included in Shares Purchased N/A N/A
(Purchased in in Year 2 and Year 3)
Year 2 and Year 3)
Shares Purchased in Year 2 N/A N/A N/A
(Vested in Year 1)
Shares Vested in Year 2 Unexercised Unadjusted Amount Yes Yes
(Unpurchased)
Shares Purchased in Year 3 Exercised Unadjusted Amount Yes Yes
(Vested in Year 1) (less the option spread included (regardless of inclusion
on Taxpayer’s Form 1040 for Year 3) of any option spread on
Form 1040 for Year 3)
Shares Vested in Year 3 Unexercised Adjusted Amount Yes Yes
(Unpurchased)
Shares Vesting After Year 3 N/A N/A N/A
LAW AND ANALYSIS
1. Issue One – Grant Date of Option
a. Law
Section 1.409A-1(b)(5)(vi)(B)(1) provides that the language the “grant date” of a
nonstatutory or other stock option, and similar phrases, refers to the date on which the
granting corporation completes the corporate action necessary to create the legally
binding right constituting the option. And further, the corporate action creating the
legally binding right constituting the option is not considered complete until the date on
which the maximum number of shares that can be purchased under the option and the
POSTU-107896-14 8
minimum exercise price are fixed or determinable, and the class of underlying stock and
the identity of the service provider is designated.
Section 1.409A-1(b)(5)(vi)(B)(1) further provides that, ordinarily, if the corporate
action provides for an immediate offer of stock for sale to a service provider, or provides
for a particular date on which the offer is to be made, the date of the granting of the
option is the date of the corporate action if the offer is to be made immediately, or the
date provided as the date of the offer, as the case may be.
Section 1.409A-1(b)(5)(vi)(B)(2) provides that, if the corporation imposes a
condition on the granting of an option (as distinguished from a condition governing the
exercise of the option), the condition generally will be given effect in accordance with
the intent of the corporation.
Section 1.409A-1(b)(5)(vi)(B)(2) also provides that, if the grant of an option is
subject to approval by stockholders, the grant date of the option will be determined as if
the option had not been subject to such approval. And further, a condition that does not
require corporate action, such as the approval of, or registration with, some regulatory
or government agency, for example, a stock exchange or the Securities and Exchange
Commission, is ordinarily considered a condition upon the exercise of the option unless
the corporation clearly indicates that the option is not to be granted until the condition
has been satisfied.
b. Analysis
Parent and Taxpayer entered into an ----------- option agreement prior to ---- -------
--------------- Date providing for the grant of the Option under the terms of the Plan.
However, Parent completed the corporate action necessary to provide for Taxpayer’s
legally binding right to the Option no earlier than one day prior to ------------------------------
-----------------------------------------------------------------------------------------------------Date, when
Parent’s --------- approved the grant of the Option. Moreover, the option agreement, as
approved by --------------, provides that the grant date of the Option is --------------------
Date and that the grant of the Option is effective on ---------------------Date. The restricted
stock agreement under which Taxpayer was granted restricted stock provides for the
same treatment. The Plan under which the Option and the restricted stock were
granted also provides that the Plan is effective on ---------------------Date.
------------------------------------------------------------------------------------------------------------
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-------------------------------------------------------------------------------------------------------------.
------------------------------------------------------------------------------------------------------------
POSTU-107896-14 9
------------, providing for the immediate grant of Taxpayer’s restricted stock and other
awards of (or based on) Parent’s ---------- common stock, the Plan could be effective no
earlier than -------------------- Date, prior to which no restricted or other shares of the ------
---------- common stock could have been issued. ----------------------------------------------------
-----------------------------------------------------------------.
Accordingly, Parent’s ---------- approval of the Option -------------------------------------
----------------------- did not provide for an immediate grant of the Option, but rather for the
grant to be made on a particular date, ---------------------Date. The fact that the option
agreement defines the grant date as ---------------------Date further indicates that Parent
intended for ---------------------Date to be the grant date of the Option. Moreover, Parent’s
---------- approval of the Plan and the grant of the Option to be effective on ------------------
--------------- Date ----------------------------------------------------------------------------------------------
------------------------------------------------------------------ imposed the same condition to the
grant of the Option, which is determinative of the grant date in accordance with Parent’s
intent.
For the foregoing reasons, ---------------------Date was the grant date of the Option.
2. Issue Two – “When Issued” Market; Section 409A Failure
a. Law
Section 1.409A-1(b)(5)(i)(A) provides that a nonstatutory stock option to
purchase a fixed number of shares of service recipient stock is not treated as a
nonqualified deferred compensation plan subject to section 409A (and therefore is
treated as exempt from section 409A) if the exercise price is not less than the fair
market value of the underlying stock on the grant date of the option and certain other
requirements are met. Conversely, if the exercise price is less than such fair market
value (or the option provides for a deferral feature or the right to purchase other than
service recipient stock), the option is treated as a nonqualified deferred compensation
plan subject to section 409A that must meet the initial deferral election and time and
form of payment requirements under the section 409A regulations.
A nonqualified deferred compensation plan subject to section 409A(a) must
provide, upon adoption of the plan or when otherwise permitted under the section 409A
initial deferral election requirements, for a deferred amount to be paid at a time and in a
form meeting the section 409A time and form of payment requirements. To satisfy the
time and form of payment requirements, the plan must designate that a specified
nondiscretionary and objectively determinable deferred amount may be paid only upon
a specified (or the earlier or later of certain specified) permissible payment event (or
events), such as a specified time or date, death, disability, separation from service, or a
change in control event, or a permissible period following the applicable payment event.
Such a permissible period must be designated to end no later than the last day of
POSTU-107896-14 10
applicable taxable year of the service provider or, if potentially later, within 90 days
following the specified permissible payment event. For a nonstatutory stock option that
is treated as a nonqualified deferred compensation plan subject to section 409A(a), the
terms of the option must accordingly designate in accordance with the initial deferral
election requirements the nondiscretionary and objectively determinable number of
shares that may be purchased through full or partial exercise of the option upon a
permissible payment event (or the earlier or later of certain permissible payment events)
or a permissible period following the applicable payment event.
For purposes of determining the fair market value of service recipient stock
underlying a nonstatutory stock option intended to be exempt from section 409A,
§1.409A-1(b)(5)(iv)(A) provides that, for stock that is readily tradable on an established
securities market, the fair market value of the stock on the grant date of the option is
determined based on a reasonable method using actual transactions in the stock as
reported by the established securities market. For example, determination of the fair
market value may be based on the last sale before or the first sale after the grant, the
closing price on the trading day before or the trading day of the grant, or the arithmetic
mean of the high and low prices on the trading day before or the trading day of the
grant.
Section 1.409A-1(b)(5)(iv)(A) further provides that the fair market value of the
stock on the grant date may be determined using an average selling price during a
specified period that is within 30 days before or 30 days after the grant date, provided
that the program under which the nonstatutory stock option is granted, including a
program with a single participant, must irrevocably specify the commitment to grant the
option with an exercise price set using such an average selling price before the
beginning of the specified period. To satisfy this requirement, §1.409A-1(b)(5)(iv)(A)
provides that the service recipient must designate the method for determining the
exercise price, including the period over which the averaging will occur, before the
beginning of the specified averaging period.
Section 1.409A-1(b)(5)(iv)(B) provides that, for service recipient stock that is not
readily tradable on an established securities market, the fair market value of the stock
on the grant date of a nonstatutory stock option is determined based on the reasonable
application of a reasonable valuation method, taking into consideration events occurring
after the date of the calculation that may materially affect the value of the service
recipient stock.
Section 1.409A-1(b)(5)(iv)(A) and §1.409A-1(b)(5)(iv)(B) read together imply that
if the underlying service recipient stock is readily tradable on an established securities
market on the grant date of a nonstatutory stock option, the fair market value of the
stock must be determined based on a reasonable method using actual transactions in
the stock as reported by the established securities market. This principle is further
indicated under §1.409A-1(b)(5)(iv)(B)(3), which provides that a valuation method under
§1.409A-1(b)(5)(iv)(A) must be used (and accordingly a valuation method under
POSTU-107896-14 11
§1.409A-1(b)(5)(iv)(B) may no longer be used) if the stock becomes readily tradable on
an established securities market.
Section 1.409A-1(k) provides that, for purposes of section 409A, the term
“established securities market” means an established securities market as defined
under §1.897–1(m).
Section 1.409A-1(b)(5)(vi)(G) provides that, for purposes of section 409A, stock
is treated as readily tradable if it is regularly quoted by brokers or dealers making a
market in the stock. In explaining §1.409A-1(b)(5)(vi)(G), the preamble to the final
section 409A regulations (72 Fed. Reg. 19,234, 19,240 (April 17, 2007)) states that the
rule was intended to adopt the same standard as that set forth under §1.280G-1, Q&A-
6(e). Section 1.280G-1, Q&A-6(e) provides that, for purposes of section 280G, stock is
treated as readily tradable if it is regularly quoted by brokers or dealers making a market
in the stock. Section 1.280G-1, Q&A-6(f) provides that, for purposes of section 280G,
the term “established securities market” means an established securities market as
defined under §1.897–1(m).
Section 1.897-1(m) provides that the term “established securities market” means
(1) a national securities exchange which is registered under section 6 of the Securities
Exchange Act of 1934 (15 U.S.C. 78f), (2) a foreign national securities exchange which
is officially recognized, sanctioned, or supervised by governmental authority, and (3)
any over-the-counter market. An over-the-counter market is any market reflected by the
existence of an interdealer quotation system. An interdealer quotation system is any
system of general circulation to brokers and dealers which regularly disseminates
quotations of stocks and securities by identified brokers or dealers, other than by
quotation sheets which are prepared and distributed by a broker or dealer in the regular
course of business and which contain only quotations of such broker or dealer.
It is a common practice for new issues of publicly traded stocks and bonds to be
traded on a “when, as and if issued” (commonly called a “when issued”) basis days prior
to when the issuer actually issues and distributes the security to holders. A when-
issued trade is made between a seller and a buyer contingent on actual issuance of the
security, after which settlement of the trade is made.
A when-issued market for a security yet to be issued may occur on an over-the-
counter market or any other established securities market as defined under §1.897-
1(m). Section 703.02 (part 1) of the New York Stock Exchange’s Listed Company
Manual provides guidelines applicable to when-issued trading on the Exchange of a
security expected to be issued as a stock dividend: “Normally, the Exchange will initiate
when issued trading when the percentage of additional stock distributed is 25% or more
of the outstanding. There is no fixed date for the commencement of when issued
trading, but the Exchange will usually wait until such time as all corporate and official
action requisite to the issuance of shares has been taken.”
POSTU-107896-14 12
The Tax Court held that a when-issued trading price on an over-the-counter
market indicates the fair market value of a security prior to its issuance. Frizzelle
Farms, Inc. v. Comm., 61 T.C. 737 (1974), aff’d 511 F.2d 1009 (4th Cir., 1975).
b. Analysis
Parent’s ---------- common stock was traded on a when-issued basis on an over-
the-counter market on ---------------------Date (Day 3), the grant date of the Option. The
over-the-counter market on which Parent’s ---------- common stock was traded was an
over-the-counter market, and therefore an established securities market, for purposes of
§1.897-1(m) because, --------------------------------------------------------------------------------------
-----------------------------------------------------------------, it occurred on an interdealer
quotation system through which the stock was regularly quoted by brokers or dealers
making a market in the stock. The fact that the ---------- common stock traded on an
established securities market in anticipation of, and contingent on, its actual issuance
does not negate that such when-issued public trading indicated the fair market value of
the stock on the applicable trading date. In fact, the trading volumes for ---------------------
-- on the over-the-counter market were among the highest recorded for the ----------
common stock over --------------------------. Therefore, the ---------- common stock is
treated for purposes of section 409A as having been readily tradable on an established
securities market on the grant date of the Option.
For purposes of meeting the requirements for exemption from section 409A of a
nonstatutory stock option for which the underlying stock is readily tradable on an
established securities market, the fair market value of Parent’s ---------- common stock
on the grant date of the Option must be determined based on a reasonable method
using actual transactions in the stock as reported by the when-issued, over-the-counter
market.
The Plan provides that, for stock traded on an over-the-counter market, the fair
market value of Parent’s ---------- common stock shall be determined, as of a particular
valuation date, by the ----------------- on such date reported by an over-the-counter
bulletin board. No documents other than the Plan and the option agreement set forth
the terms of the Option. Neither the Plan nor the option agreement designates another
method for determining the exercise price per Option Share. Therefore, the terms of the
Plan for determining the fair market value of the ---------- common stock as of a
particular valuation date designate the method for determining the applicable exercise
price per Option Share for purposes of meeting the requirements for exemption of the
Option from section 409A.
The fair market value of a share of Parent’s ---------- common stock on ---- ---------
--------------- Date, the grant date of the Option, was higher than the Exercise Price, the
exercise price per Option Share under the terms of the option agreement. On ---- --------
--------------- Date (Day 3), the lowest when-issued, over-the-counter trading price was
POSTU-107896-14 13
over $------ more than the Exercise Price. Therefore, the --------------- on ---------------------
Date is assumed to have been higher than the Exercise Price.
The Option does not meet the requirements under §1.409A-1(b)(5)(i)(A) for
exemption from section 409A because the exercise price per Option Share, based on
the Exercise Price, was less than the fair market value per Option Share on the grant
date of the Option. Because the Option did not comply with the requirements under
§1.409A-1(b)(5)(i)(A) to be exempt from section 409A, the Option is treated as a
nonqualified deferred compensation plan subject to section 409A(a) from the grant date
until the end of the taxable year during which the Option is either fully exercised or
expires.
Because the option agreement provides that Option Shares could generally be
purchased through exercise of the Option at any time following vesting and before -------
--------------------------------------------------------, the terms of the Option do not designate a
permissible payment event or a permissible period following such payment event as the
only time that a specified number of Option Shares could be purchased. Therefore, the
Option failed to meet the requirements of section 409A(a) from the grant date, ------------
--------------- Date.
-
Issue Three – Income Tax Calculation for Section 409A Failure
a. Law
Income Inclusion under Section 409A(a)(1)(A)(i)
Section 409A(a)(1)(A)(i) provides that, if at any time during a taxable year anonqualified deferred compensation plan (I) fails to meet the requirements of
paragraphs (2), (3), and (4) of section 409A(a), or (II) is not operated in accordance with
such requirements, all compensation deferred under the plan for the taxable year and
all preceding taxable years shall be includible in gross income for the taxable year to the
extent not subject to a substantial risk of forfeiture and not previously included in gross
income.The Treasury Department and the IRS issued proposed regulations under
section 409A(a)(1) on December 8, 2008 (73 Fed. Reg. 74380), which have not yet
been finalized. The proposed regulations propose to add §1.409A-4 to the section
409A regulations. Prop. §1.409A-4 proposes rules on the calculation of the amount
includible in income under section 409A(a)(1)(A)(i) and the additional taxes under
section 409A(a)(1)(B)(i).Part V of IRS Notice 2008-115, 2008-52 I.R.B. 1367, provides that, until Prop.
§1.409A-4 is finalized, taxpayers may rely on the rules under Prop. §1.409A-4 in
calculating the amount of the income inclusion and additional taxes under section
POSTU-107896-14 14
409A(a)(1) for purposes of ensuring that the requirements of section 409A(a)(1) are
met.
Prop. §1.409A-4(a)(1)(i) provides that the amount includible in income under
section 409A(a)(1)(A)(i) for a service provider’s taxable year due to a failure to meet the
requirements of section 409A(a) with respect to a plan is the excess (if any) of (A) the
service provider’s total amount deferred under the plan for the taxable year, including
the amount of any payments of amounts deferred under the plan to (or on behalf of) the
service provider during the taxable year; over (B) the portion of such amount, if any, that
is either subject to a substantial risk of forfeiture (as defined under §1.409A-1(d) and
applying Prop. §1.409A-4(a)(1)(ii)(B)) or has been previously included in income (as
defined under Prop. §1.409A-4(a)(3)).
Prop. §1.409A-4(b)(6) provides rules for determining the total amount deferred
for the taxable year of a section 409A failure under a nonstatutory stock option or other
stock right subject to section 409A. Under Prop. §1.409A-4(b)(6), if a stock right
remains unexercised and outstanding on the last day of the service provider’s taxable
year, the total amount deferred under the stock right for the taxable year is the excess
of the fair market value of the underlying stock on the last day of the taxable year
(determined in accordance with §1.409A-1(b)(5)(iv)) over the sum of the stock right’s
exercise price plus any amount paid for the stock right. However, if a stock right has
been exercised during the service provider’s taxable year, the total amount deferred
under the stock right for the taxable year is the excess of the fair market value of the
underlying stock (determined in accordance with §1.409A-1(b)(5)(iv)) on the date of
exercise over the sum of the exercise price of the stock right and any amount paid for
the stock right.
Prop. §1.409A-4(a)(2)(i) provides that the portion of the total amount deferred
under a plan for a taxable year that is subject to a substantial risk of forfeiture is
determined as of the last day of the service provider’s taxable year. Therefore, any
amount deferred under a plan that remains unvested as of the end of the taxable year of
the section 409A failure is not subject to income inclusion under section 409A(a)(1)(A)(i)
for the taxable year.
Prop. §1.409A-4(a)(3) provides that an amount has been previously included in
income only if the service provider has actually included the amount in income under an
applicable Code section for a previous taxable year. Prop. §1.409A-4(a)(3) further
provides that, for future taxable years, the amount previously included in income is
reduced to reflect any amount that was paid during the taxable year for which the
amount was included in income, any amount allocated (under Prop. §1.409A-4(f)) to a
payment of an amount included in income under section 409A(a)(1)(A)(i), and any
amount deductible (under Prop. §1.409A-4(g)) due to forfeitures or other permanent
loss of right to amounts included in income under section 409A(a)(1)(A)(i).
POSTU-107896-14 15
Prop. §1.409A-4(a)(1)(ii) provides that an amount is includible in income under
section 409A(a)(1)(A)(i) for a taxable year only if a plan fails to meet the requirements of
section 409A(a) during the taxable year. Prop. §1.409A-4(a)(1)(ii) further provides that
whether a plan fails to meet the requirements of section 409A(a) during a taxable year
is determined independently of whether the plan fails to meet the requirements of
section 409A(a) during a previous or subsequent taxable year, except to the extent
provided under Prop. §1.409A-4(a)(3). Accordingly, the consequences of a section
409A failure are determined independently for any particular taxable year during which
the failure occurs or continues to occur without regard to such consequences affecting
any other taxable year. However, the service provider would receive credit (subject to
Prop. §1.409A-4(a)(3)) for amounts previously included in income under section
409A(a)(1)(A)(i) due to a section 409A failure under the plan.
Section 409A(c) provides that any amount included in gross income under
section 409A(a)(1)(A)(i) is not required to be included in gross income under any other
Code section or any other rule of law later than the time provided under section
409A(a)(1)(A)(i). Prop. §1.409A-4(f)(1) accordingly provides that an amount included in
income under section 409A(a)(1)(A)(i) that has neither been paid in the taxable year the
amount was included in income under section 409A(a)(1)(A)(i) nor served as the basis
for a deduction under Prop. §1.409A-4(g)(1) is allocated to payments of amounts
deferred under the plan in taxable years subsequent to the taxable year the amount was
included in income under section 409A(a)(1)(A)(i).
Prop. §1.409A-4(g)(1) provides that, if a service provider has included an amount
in income under section 409A(a)(1)(A)(i), but has not actually received payment of such
amount or otherwise allocated the amount under Prop. §1.409A-4(f)(1), the service
provider is entitled to a deduction for the taxable year in which the right to the amount is
permanently forfeited under the plan’s terms or the right to the payment of the amount is
otherwise permanently lost.
Prop. §1.409A-4(f)(2) provides that the plan aggregation rules of §1.409A-1(c)(2)
apply to the allocation under Prop. §1.409A-4(f)(1) of amounts previously included in
income under section 409A(a)(1)(A)(i) to payments made under the plan. Therefore,
the service provider is entitled to allocate an amount previously included in income
under section 409A(a)(1)(A)(i) to payments of amounts deferred under any aggregated
plan.
Prop. §1.409A-4(g)(2) provides that the plan aggregation rules of §1.409A-1(c)(2)
apply to determine whether the right to an amount deferred under a plan is permanently
forfeited or otherwise lost. Accordingly, if the right to an identified amount deferred
under a plan is permanently forfeited or otherwise lost, but an additional amount
remains deferred under any aggregated plan, the service provider is not entitled to a
deduction under Prop. §1.409A-4(g)(1).
Additional 20% Tax under Section 409A(a)(1)(B)(i)(II)
POSTU-107896-14 16
Section 409A(a)(1)(B)(i)(II) provides that, if compensation is includible in income
under section 409A(a)(1)(A)(i) for a taxable year, the income tax imposed is increased
by an amount equal to 20% of the compensation that is includible in income. This
amount is an additional income tax, subject to the rules governing the assessment,
collection, and payment of income tax, and is not an excise tax.
Prop. §1.409A-4(c) provides that an amount includible in income under section
409A(a)(1)(A)(i) for a taxable year is subject to the additional 20% income tax under
section 409A(a)(1)(B)(i)(II). Applying Prop. §1.409A-4(a)(1)(i), the amount subject to
the additional 20% income tax is the excess (if any) of (A) the total amount deferred
under the plan for the taxable year (including the amount of any payments during the
taxable year of amounts deferred under the plan); over (B) the portion of such amount, if
any, that is either subject to a substantial risk of forfeiture (as defined under §1.409A-
1(d) and applying Prop. §1.409A-4(a)(1)(ii)(B)) as of the end of the taxable year or has
been previously included in income (subject to Prop. §1.409A-4(a)(3)).
Additional Interest Income Tax under Section 409A(a)(1)(B)(i)(I)
Section 409A(a)(1)(B)(i)(I) provides that, if compensation is includible in income
under section 409A(a)(1)(A)(i) for a taxable year, the income tax imposed is increased
by an amount equal to the amount of interest determined under section
409A(a)(1)(B)(ii). This amount is an additional income tax, subject to the rules
governing assessment, collection, and payment of income tax, and is not an excise tax
or interest on an underpayment.
Section 409A(a)(1)(B)(ii) provides that the additional interest income tax is
determined as the amount of interest at the underpayment rate plus one percentage
point on the underpayments that would have occurred had the deferred compensation
been includible in gross income for the taxable year during which first deferred or, if
later, the first taxable year during which the deferred compensation is not subject to a
substantial risk of forfeiture.
Prop. §1.409A-4(d)(1) provides that an amount includible in income under
section 409A(a)(1)(A)(i) for a taxable year is subject to an additional interest income tax
(premium interest tax) under section 409A(a)(1)(B)(i)(I) and section 409A(a)(1)(B)(ii)
equal to the amount of interest at the underpayment rate plus one percentage point on
the underpayments that would have occurred had the deferred amount been includible
in the service provider’s income for the taxable year during which first deferred or, if
later, the first taxable year during which the deferred amount is not subject to a
substantial risk of forfeiture.
Prop. §1.409A-4(d)(1) further provides that only the amount that is includible in
income under section 409A(a)(1)(A)(i) for a taxable year is required to be allocated to
determine the premium interest tax, regardless of whether additional amounts were
POSTU-107896-14 17
deferred under the plan in previous taxable years. Applying Prop. §1.409A-4(a)(1)(i),
the amount subject to the premium interest tax is the excess (if any) of (A) the total
amount deferred under the plan for the taxable year (including the amount of any
payments during the taxable year of amounts deferred under the plan); over (B) the
portion of such amount, if any, that is either subject to a substantial risk of forfeiture (as
defined under §1.409A-1(d) and applying Prop. §1.409A-4(a)(1)(ii)(B)) as of the end of
the taxable year or has been previously included in income (subject to Prop. §1.409A-
4(a)(3)).
Accordingly, section 409A(a)(1)(B)(ii) and Prop. §1.409A-4(d)(1) require that the
amount subject to the premium interest tax for a taxable year be allocated to the prior
taxable year (or years) the applicable portion, treated as a hypothetical underpayment,
was first deferred and vested. Interest based on a premium interest rate equal to the
underpayment rate plus one percentage point is then calculated based on the
hypothetical underpayment for each prior taxable year to reflect the time value of the
amount of the underpayment when it was first deferred and vested.
Under the calculation method set forth under Prop. §1.409A-4(d)(2), payments,
deemed investment or other losses, and amounts previously included in income under
section 409A(a)(1)(A)(i) are allocated to amounts deferred and vested under the plan
during the earliest taxable year. This results in a reduction of hypothetical
underpayments for the taxable year (or years) prior to the taxable year during which the
409A failure occurs. Any deferred amount that is not allocable to a prior taxable year is
treated as first deferred in the taxable year during which the section 409A failure occurs
and therefore as not subject to the premium interest tax (assuming that the service
provider timely includes the amounts in income for such taxable year). As stated in the
preamble to Prop. §1.409A-4(d)(2) (73 Fed. Reg. 74,380, 74,390 (December 8, 2008)),
this calculation method is intended to result in the lowest possible amount of premium
interest tax, because deferred amounts includible in income under section
409A(a)(1)(A)(i) would be treated as first deferred and vested in the latest possible
taxable years.
Prop. §1.409A-4(d)(3) provides that a hypothetical underpayment allocated to a
taxable year prior to the taxable year during which the section 409A failure occurs is
treated as an additional cash payment of compensation to the service provider for the
year. Prop. §1.409A-4(d)(3) further provides that the hypothetical underpayment is
calculated based on the service provider’s taxable income, credits, filing status, and
other tax information for the taxable year, based on the service provider’s original return
filed for the year, as adjusted by any examination for the year or any amended return
the service provider filed for the year that was accepted by the Commissioner. The
hypothetical underpayment must reflect the effect that the additional compensation
would have had on the service provider’s Federal income tax liability for the year,
including the continued availability of any deductions taken, and the use of any
carryovers such as carryover losses. Any changes to the service provider’s Federal
income tax liability for any subsequent taxable year that would have occurred if the
POSTU-107896-14 18
hypothetical underpayment had been included in the service provider’s income for a
prior taxable year must be taken into account.
Prop. §1.409A-4(d)(4) provides that the amount of premium interest tax on
hypothetical underpayments is determined for any prior taxable year by applying the
applicable rate of interest under section 6621 plus one percentage point to determine
the underpayment interest under section 6601 that would be due for the underpayment
as of the last day of the taxable year of the section 409A failure. Prop. §1.409A-4(d)(4)
further provides that the total premium interest tax applicable to a section 409A failure is
the sum of the separate amounts of premium interest tax on hypothetical
underpayments for all prior taxable years for which they exist.
b. Analysis
Income Inclusion under Section 409A(a)(1)(A)(i)
Because the Option failed to meet the requirements of section 409A(a), the
Option is subject to section 409A(a)(1)(A)(i) and Prop. §1.409A-4(a)(1)(i). Under Prop.
§1.409A-4(a)(1)(i), the total amount deferred under the Option at the end of the taxable
year of the Section 409A failure, including any payments of deferred amounts made
under the Option during the taxable year, is includible in income under section
409A(a)(1)(A)(i) to the extent not subject to a substantial risk of forfeiture as of the end
of the taxable year or included in income for a prior taxable year.
The taxable year of the section 409A failure is Year 3, the taxable year under
exam. Although the Option had failed to meet the requirements of section 409A(a) from
the grant date, for purposes of this advice, the statute of limitations on assessments is
assumed to have expired for Year 1 and Year 2. The consequences of the section
409A failure are determined independently for Year 3 without regard to such
consequences affecting any other taxable year, except that Taxpayer would receive
credit for any amounts included in income under section 409A(a)(1)(A)(i) for a prior
taxable year (subject to Prop. §1.409A-4(a)(3)).
No amounts have been included in income under section 409A(a)(1)(A)(i) for any
taxable year prior to Year 3 due to the failure of the Option to meet the requirements of
section 409A(a).
By the end of Year 3, all of the Unadjusted Shares (---- of the original Option
Shares) had vested, and Taxpayer had partially exercised the Option to purchase -----
of the Unadjusted Shares (---- of the original Option Shares), with ----- of the Unadjusted
Shares (---- of the original Option Shares) remaining unpurchased. Some of the
Unadjusted Shares (Year 2 Exercised Shares) were purchased during Year 2, and
some (Year 3 Exercised Shares) were purchased during Year 3. By the end of Year 3, -
---- of the Adjusted Shares (---- of the original Option Shares) had vested.
POSTU-107896-14 19
For purposes of this advice, it is assumed that the Option Shares that remained
unvested at the end of Year 3 were, under the circumstances, subject to a substantial
risk of forfeiture for purposes of section 409A as of the end of Year 3 and therefore not
subject to income inclusion under section 409A(a)(1)(A)(i) for Year 3. Such unvested
Option Shares include ---- of the Adjusted Shares (---- of the original Option Shares).
However, because the section 409A failure will continue to occur until the end of the
taxable year during which the Option is fully exercised or expires, the deferred amounts
applicable to such Adjusted Shares are subject to section 409A(a)(1)(A)(i) beginning
with the subsequent taxable year during which they vest.
Compensation related to Taxpayer’s purchase of Year 2 Exercised Shares is not
subject to section 409A(a)(1)(A)(i) for Year 3 because, under Prop. §1.409A-4(b)(6), it
does not constitute an amount deferred (or a payment) under the Option at any time
during Year 3. However, compensation related to Taxpayer’s purchase of Year 3
Exercised Shares is subject to section 409A(a)(1)(A)(i) for Year 3 because, under Prop.
§1.409A-4(a)(1)(i) and Prop. §1.409A-4(b)(6), it constitutes payment of amounts
deferred under the Option during Year 3.
Accordingly, the total amount deferred under the Option for Year 3 subject to
income inclusion under section 409A(a)(1)(A)(i) for Year 3 is comprised of two
components: (1) the portion that was vested and deferred (that is, unexercised and
outstanding) at the end of Year 3 and (2) the portion related to payments of amounts
deferred under the Option (that is, as the result of exercise) during Year 3. The portion
that was vested and deferred at the end of Year 3 includes the (vested) Unadjusted
Shares that remained unpurchased at the end of Year 3 (Unexercised Unadjusted
Shares) and the Adjusted Shares that had vested but remained unpurchased by the end
of Year 3 (Unexercised Adjusted Shares). The portion relating to payments of amounts
deferred under the Option during Year 3 includes the Year 3 Exercised Shares.
For purposes of determining the amount includible in income under section
409A(a)(1)(A)(i) related to the portion that was vested and deferred (that is, unexercised
and outstanding) at the end of Year 3, under Prop. §1.409A-4(b)(6), the applicable
deferred amount is the excess of the fair market value of Parent’s ---------- common
stock on the last day of Year 3 (determined in accordance with §1.409A-1(b)(5)(iv)) over
the sum of the exercise price and any amount paid for the Option (the “option spread”).
Taxpayer did not pay any amount for the Option other than the exercise price per
purchased Option Share.
------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
POSTU-107896-14 20
-------------------------------------------------------------------------------------.
The option spread applicable to each Unexercised Unadjusted Share
(Unexercised Unadjusted Spread) is accordingly determined on the basis of the excess
of the ------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------- (Year 3 Closing Price) over the
Exercise Price (the exercise price per Unadjusted Share). Similarly, the option spread
applicable to each Unexercised Adjusted Share (Unexercised Adjusted Spread) is
determined on the basis of the excess of the Year 3 Closing Price over the Adjusted
Exercise Price (the exercise price per Adjusted Share).
The product of the Unexercised Unadjusted Spread and the number of
Unexercised Unadjusted Shares is the deferred amount applicable to the Unexercised
Unadjusted Shares (Unexercised Unadjusted Amount). Similarly, the product of the
Unexercised Adjusted Spread and the number of Unexercised Adjusted Shares is the
deferred amount applicable to the Unexercised Adjusted Shares (Unexercised Adjusted
Amount). The sum of the Unexercised Unadjusted Amount and the Unexercised
Adjusted Amount is the aggregate amount includible in income under section
409A(a)(1)(A)(i) for the portion of the Option that was vested and deferred (that is,
unexercised and outstanding) at the end of Year 3.
For purposes of determining the amount includible in income under section
409A(a)(1)(A)(i) related to payments of amounts deferred under the Option (that is, as
the result of exercise) during Year 3, under Prop. §1.409A-4(b)(6), the applicable
deferred amount is the excess of the fair market value of the Year 3 Exercised Shares
(as determined in accordance with §1.409A-1(b)(5)(iv)) on the date of exercise over the
sum of the exercise price and any amount paid for the Option (the “option spread”).
Taxpayer partially exercised the Option during Year 3 to purchase, at the
Exercise Price, a certain number of Unadjusted Shares (Year 3 Exercised Shares). The
option spread per share applicable to the exercise is determined on the basis of the
excess of the ----------------------- price per share on the applicable exercise date of
Parent’s ---------- common stock ----------------------------------------------- over the Exercise
Price (the exercise price per Unadjusted Share).
The product of the option spread per share and the number of Year 3 Exercised
Shares purchased on the exercise date is the deferred amount applicable to the
exercise (Exercised Unadjusted Amount) includible in income under section
409A(a)(1)(A)(i) for the portion of the Option related to payment of amounts deferred
under the Option (that is, as the result of exercise) during Year 3.
Although the Exercised Unadjusted Amount is subject to income inclusion under
section 409A(a)(1)(A)(i), the amount should have been included in Taxpayer’s income
on Taxpayer’s Form 1040 for Year 3 because it represents the compensatory amount
POSTU-107896-14 21
that is includible in income under section 83 and §1.83-7 for the taxable year of exercise
(and includible on a Form W-2 issued to Taxpayer). However, because it is treated as a
vested amount deferred under the Option for Year 3 (no part of which was included in
income for a prior taxable year), the Exercised Unadjusted Amount is subject to income
inclusion under section 409A(a)(1)(A)(i) for purposes of calculating the additional 20%
income tax under section 409A(a)(1)(B)(i)(II) and the additional premium interest
income tax under section 409A(a)(1)(B)(i)(I).
Accordingly, the Unexercised Unadjusted Amount, the Unexercised Adjusted
Amount, and the Exercised Unadjusted Amount (the sum of which is the Total Deferred
Amount) are subject to income inclusion under Section 409A(a)(1)(A)(i) on account of
the section 409A failure for Year 3.
Additional 20% Tax under Section 409A(a)(1)(B)(i)(II)
Because the Option failed to meet the requirements of section 409A(a) for Year
3, the amount subject to income inclusion under section 409A(a)(1)(A)(i) and Prop.
§1.409A-4(a)(1)(i) for Year 3 (Total Deferred Amount) is subject to an additional 20%
tax under section 409A(a)(1)(B)(i)(II) and Prop. §1.409A-4(c) for Year 3.
The additional 20% tax for Year 3 is the product of .20 and the Total Deferred
Amount (20% Tax Amount). It is not relevant for purposes of calculation of the 20% Tax
Amount that any portion of the Exercised Unadjusted Amount may have otherwise been
included in income on Taxpayer’s Form 1040 for Year 3.
Accordingly, the 20% Tax Amount is an additional income tax under Section
409A(a)(1) due on account of the section 409A failure for Year 3.
Additional Interest Income Tax under Section 409A(a)(1)(B)(i)(I)
Because the Option failed to meet the requirements of section 409A(a) for Year
3, the amount subject to income inclusion under section 409A(a)(1)(A)(i) and Prop.
§1.409A-4(a)(1)(i) for Year 3 (Total Deferred Amount) is subject to an additional interest
income tax (premium interest tax) under section 409A(a)(1)(B)(i)(I) and Prop. §1.409A-
4(d) for Year 3.
Because calculation of the premium interest tax must take account of Taxpayer’s
other tax attributes for the applicable taxable years, advice on calculation of the
premium interest tax for Year 3 will be provided separately. It is not relevant for
purposes of calculation of the premium interest tax that any portion of the Exercised
Unadjusted Amount may have otherwise been included in income on Taxpayer’s Form
1040 for Year 3.
Accordingly, the premium interest tax is an additional income tax under Section
409A(a)(1) due on account of the section 409A failure for Year 3.
POSTU-107896-14 22
c. Summary
The following is a summary of the amounts subject to income inclusion and
additional taxes under section 409A(a)(1) for Year 3 on account of the section 409A
failure under the Option for Year 3.
Includible Amounts. For Year 3, the following amounts are includible in
Taxpayer’s income under section 409A(a)(1)(A)(i) and Prop. §1.409A-4(a)(1)(i) and
reportable on Taxpayer’s Form 1040 for Year 3:
Unexercised Unadjusted Amount
Unexercised Adjusted Amount
Potentially Includible Amount. For Year 3, the following amount is includible in
Taxpayer’s income under section 409A(a)(1)(A)(i) and Prop. §1.409A-4(a)(1)(i) and
reportable on Taxpayer’s Form 1040 for Year 3; however, the amount is not so
includible to the extent that it has already been included on a Form W-2 issued to
Taxpayer and reported on Taxpayer’s Form 1040 for Year 3:
Exercised Unadjusted Amount
Additional 20% Income Tax. For Year 3, the following amounts are subject to an
additional 20% income tax under section 409A(a)(1)(B)(i)(II) and Prop. §1.409A-4(c),
which amount (20% Tax Amount) is treated as an additional income tax reportable on
Taxpayer’s Form 1040 for Year 3:
Unexercised Unadjusted Amount
Unexercised Adjusted Amount
Exercised Unadjusted Amount
Additional Interest Income Tax. For Year 3, the following amounts are subject to
an additional interest income tax (premium interest tax) under section 409A(a)(1)(B)(i)(I)
and Prop. §1.409A-4(d), which amount is treated as an additional income tax reportable
on Taxpayer’s Form 1040 for Year 3:
Unexercised Unadjusted Amount
Unexercised Adjusted Amount
Exercised Unadjusted Amount
Amounts Not Subject to Section 409A(a)(1) Income Inclusion and Additional
Taxes. The following amounts are not includible in Taxpayer’s income under section
409A(a)(1)(A)(i) and Prop. §1.409A-4(a)(1)(i), not subject to an additional 20% income
tax under section 409A(a)(1)(B)(i)(II) and Prop. §1.409A-4(c) and an additional interest
income tax under section 409A(a)(1)(B)(i)(I) and Prop. §1.409A-4(d), and not reportable
POSTU-107896-14 23
on Taxpayer’s Form 1040, for Year 3; however, the amounts will become so includible
in Taxpayer’s income, subject to the additional section 409A(a)(1) taxes, and reportable
on Taxpayer’s Form 1040 for Taxpayer’s taxable years during which they vest (or
remain unexercised and outstanding):
Deferred amounts applicable to ---- of the Adjusted Shares (---- of the original
Option Shares) that remained unvested as of the end of Year 3.
This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.
Please call -------------------- if you have any further questions.
By: _____________________________
John B. Richards
Senior Technician Reviewer
Executive Compensation Branch
(Employee Benefits)
Tax Exempt & Government Entities
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