We have been thinking and talking about Section 409A for more than 8 years now, but most of that discussion has been hypothetical. We have pursued compliance with Section 409A, but have been left to wonder: What would actually happen if an arrangement violated Section 409A? Is the IRS monitoring compliance or enforcing these requirements?
Well now we have some answers.
A federal court recently issued a ruling (here) dealing with the consequences under Section 409A of a discounted stock option arrangement. In addition to providing some specific legal analysis on Section 409A issues, the court’s decision provides some insights into how a case like this might arise.
Background. The case involves a founder and senior executive of a technology company (Marvell Semiconductor) who was granted stock options in 2003. In the wake of the various stock option backdating scandals, the company reviewed its option program and repriced the 2003 option grant. As a result, the executive paid over $5,000,000 in additional exercise price, presumably reflecting that the options had been substantially discounted when awarded.
The IRS Takes Notice. Disclosures regarding this repricing must have caught the IRS’s attention. In 2010, it issued the executive a notice of deficiency to the executive assessing additional taxes and penalties under Section 409A in excess of $3,000,000. The executive paid the assessed amounts and then sued to obtain a refund, arguing that the option arrangement was not governed by Section 409A.
The Court’s Analysis. The court made several important rulings regarding the impact of Section 409A for Continue Reading...