Section 409A Implications Of Discounted Stock Options

Employers are generally aware that Section 409A of the Internal Revenue Code of 1986 ("Section 409A") applies to deferred compensation but may not be aware that it can also apply to certain stock option programs, which could result in compliance problems. A non-qualified stock option¹ is not treated as deferred compensation under Section 409A if three conditions are met:

1. The exercise price can never be less than the fair market value of the underlying stock on the date of grant and the number of shares subject to the option is fixed on the grant date;
2. The exercise of the option is taxable under Code Section 83; and
3. The option does not include any feature allowing the grantee to defer compensation, other than the deferral of income until the later of (a) the exercise of the option; or (b) the date the stock acquired through exercise of the option becomes vested.