Backdated Options are Unreasonable Compensation
Posted: 19 Feb 2007
In this article, Prof. Zelinsky observes that, in its enforcement of section 162(a)(1) and its rule of reasonable compensation, the IRS has focused its enforcement efforts exclusively on the compensation granted by successful closely held C corporations to their shareholder-employees. The IRS has ignored the enormous compensation packages that the nation's publicly traded corporations now routinely pay to their CEOs and other top executives.
Judging from its response to the option backdating scandal, Zelinsky believes the IRS will either begin to rectify the anomaly that is the law of reasonable compensation or will compound the incoherence and unfairness of current law.
Backdated options are in-the-money options disguised to look like at-the-money options by means of falsely reported issuance dates. Under section 162(m) and its regulations, gain from the exercise of in-the-money options is not performance-based income and therefore is typically nondeductible with respect to corporations' covered employees. Moreover, compensation earned by other executives from the exercise of backdated options is unreasonable and hence nondeductible to the corporations employing those executives.
Zelinsky hopes the IRS will bring to bear on the publicly traded corporations issuing backdated options the same zeal with which it has enforced reasonable compensation limits against closely held corporations. In the final analysis, backdated options are unreasonable compensation.
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