Discounted Stock Options Raise Code Section 409A Considerations

Summary

Companies generally grant stock options to employees, consultants, or non-employee directors to align their compensation with an increase in company value over time. Prior to the adoption of Section 409A of the Code (''Section 409A''), companies often granted options with an exercise price that was less than the fair market value of the common stock on the date of grant. The enactment of Section 409A, however, greatly reduced the practice of granting discounted options to service providers in the U.S. (''U.S. Service Providers''), because to avoid a 20% additional tax on the options, the options must either be compliant with Section 409A and only exercisable on a Section 409A permissible payment event (i.e., death, disability, separation from service, change in control, a fixed date or fixed schedule), or only exercisable during the short-term deferral period (as discussed in more detail below).