California Collects Backdating Taxes from 46 Companies

The state's program gives rank-and-file employees tax relief for misdated options, but not executives or other corporate insiders.
Sarah JohnsonSeptember 7, 2007

Nearly 50 California companies have paid state taxes incurred by rank-and-file employees when they exercised stock options that had been backdated or mispriced last year.

California’s tax-administration agency, the Franchise Tax Board, announced on Thursday that it had collected nearly $31 million from 46 employers who signed on to the voluntary program earlier this year. The state program followed a similar initiative by the Internal Revenue Service. The IRS gave companies the ability to take on the added tax liability from their employees, but excluded top executives and other company insiders from the program.

A 2004 federal tax law governing deferred compensation dictates that improperly priced options could trigger a 20 percent surtax and additional interest on income tax. Rank-and-file employees, however, may not have been aware of the tax consequences or that their stock options had been mispriced.

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California’s tax board estimates that nearly 3,700 employees benefited from its program. Their employers paid the 20 percent penalty plus interest that the workers would have had to pay when they exercised the options. To take part, companies had to notify the board by March 15 and pay the taxes by June 30.

The state program minimized “the burdens of compliance on employees who are not corporate insiders, while ensuring all applicable taxes are paid,” according to the tax board. The program applied only to stock options exercised in 2006 that were subject to IRC Section 409A. They also had to have an exercise price below the fair-market value of the underlying stock on the date of the grant.

To figure out how much they owed under the state program, companies made several calculations. For the 20 percent surcharge, for example, they took 20 percent of the excess of the fair-market value of the stock on the exercise date over the total exercise price that was paid by the employee, as well as any other amount that the employee paid for the stock right.