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.
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.
Unlike the abusive corporate tax shelter ploys which often involve complex manipulation of a transaction to achieve tax results that are inconsistent with the economic reality of the deal, stock option backdating is a relatively crude device: A corporation merely changes the date that a stock option was actually granted to an earlier time when the stock price was lower.
Thus, the option becomes "in the money", meaning there was a built-in profit on the underlying stock, on the grant date.
The stock option backdating scandal shows no signs of abating and the newly-discovered backdating of the date of exercise may give corporate American another black-eye.
Expect IRS to aggressively pursue this cheating since it amounts to tax fraud and evasion, pure and simple, and is relatively easy to prove.Another variation on the stock option backdating scheme has emerged.Instead of merely backdating the grant date to achieve a lower exercise price, the SEC has begun investigating whether executives have backdated the exercise date.Mike will have paid taxes on ,000,000 of ordinary income (taxed at a maximum of 35% federal) and will have 0,000 of short-term capital gains in the following year (taxed at ordinary income rates), since the stock rose /share since the date of exercise (100,000 x 5/share = 0,000).Backdating the date of exercise, rather than the date of grant, provides the employee with a double tax benefit and does not run afoul of IRC Secs. 422, since these code provisions address in-the-money options on the date of grant, not exercise.However, by backdating the grant date to the date when Mike was offered the stock options (September 1st), the option price is lowered to /share and Mike receives built-in gain on the "spread" between the exercise price and the fair market value of the stock of /share or ,000,000.