With the holidays in full swing and less than one week remaining in 2022, we wanted to pass along a few compensation income tax related stocking stuffer reminders in connection with the year-end for which companies and/or individuals may want to consult about with their advisors (and in particular to see if they should take any actions before 2023). For simplicity, this blog assumes that the calendar year is the income tax year for both service providers and service recipients.

1) Stock Option Items – Exercising a nonstatutory stock option in 2022 will mean that the gain from such exercise will be included in the optionee’s 2022 taxable income. This could be beneficial to an optionee who anticipates lower income tax rates or liability after 2022 and/or who wishes to increase his/her Internal Revenue Code (“Code”) Section 280G “base amount” for purposes of possibly reducing/eliminating golden parachute excise tax liability under Code Sections 280G and 4999. These golden parachute tax statutes can impose a 20% federal excise tax on a service provider’s change in control contingent compensation (and also a loss of an income tax deduction for the employer) that exceeds the individual’s Code Section 280G base amount (if such contingent compensation also equals or exceeds 300% of the individual’s base amount). The Code Section 280G base amount is a running average of an individual’s taxable compensation for the five tax years immediately preceding the tax year of a change in control and so an individual who is subject to Code Section 280G and who anticipates a change in control event for his/her employer in 2023 could potentially benefit from having an increased base amount. 

Separately, we note that if an optionee sells shares acquired from an ISO exercise in the same tax year as the year of the ISO exercise, then such sale of shares is considered to be a “disqualifying disposition” for purposes of the ISO and moreover this means that no Code Section 55 alternative minimum tax could be imposed on such ISO exercise. Also, any Code Section 422 incentive stock options (“ISOs’) that are exercised in 2022 will need to be reported by employers to the IRS/optionees in 2023 on IRS Form 3921 and we will look to send out a January 2023 blog discussing this reporting item in further detail. 

2) Internal Revenue Code Section 409A (“409A”) Items – This complex tax statute governing nonqualified deferred compensation has a few items that merit consideration at the end of each calendar year. 

While there are some exceptions, initial elections to defer future compensation under 409A generally need to be irrevocably implemented before the tax year in which the underlying services are rendered (i.e., initial deferral elections must be completed on or before December 31, 2022). 

In order to not violate 409A, compensatory stock options generally need to have a per share exercise price that is not less than the fair market value of a share underlying the option on the date of option grant. If post-grant the option exercise price is determined to not satisfy this pricing requirement, then the current 409A regulatory guidance (see IRS Notice 2008-1113) permits this defect to be corrected if (in the same tax year of the option’s grant) the stock option’s per share exercise price is repriced upwards to be at least equal to the actual share fair market value on the option grant date. 

While the foregoing option exercise price issue typically would just affect companies that are not publicly traded, companies who are publicly traded have their own year-end item. Specifically, such public companies should annually update their “specified employee identification list” of “specified employees” (who are subject to limitations under 409A with respect to receiving certain nonqualified deferred compensation distributions during the first six months after termination of their service with their employer) and generally this list needs to be updated shortly after the end of each calendar year.

3) Internal Revenue Code Section 280G (“280G”) Items – In addition to the 280G base amount point referenced above in 1), change in control transactions which originally were scheduled to be consummated in 2022 but ultimately are completed in 2023 will need to have their 280G numerical analyses updated to reflect base amounts covering calendar 2018 through 2022 (instead of 2017 through 2021). This update of the applicable base amounts could affect whether or not a given individual is or is not subject to 280G excise taxes.

4) Rescission – Transactions effected in 2022 can under certain circumstances potentially be rescinded by the applicable parties in 2022 to place such parties back in the same place they otherwise would have been in had the underlying transaction never occurred (see IRS Rev, Rul. 80-58). One essential condition for effecting a tax compliant rescission is that the rescission be executed in the same calendar year as the year in which the transaction occurred.