We therefore focus on the value at exercise (and eventual sale of the shares) and demonstrate the role the income tax regime plays in determining the after-tax value to the executive. The long-term capital gains rate remains applicable for AMT purposes; in other words, the reduced rate is not treated as a tax preference for AMT purposes. This article considers in detail the potential role of personal income taxation in influencing demand for backdated options in Canada relative to the United States.
Instead, we are simply advocating that a thorough explanation of the causes of backdating necessitates in-depth consideration of each relevant factor in turn and its potential contribution to backdating. We appreciate that income tax treatment is one piece of a larger puzzle that constitutes demand for backdated options by executives. The amount included in income (for both regular tax and AMT purposes) is the difference between the sale price of the share and the strike price under the option.
Another piece is the insider reporting obligations imposed upon some executives by securities regulations. Given a lenient disclosure regime for reporting the grant and exercise of stock options, as some have argued currently exists in Canada, backdating could easily go undetected.
Greed is often cited as the motive for backdated options. However, while greed could account for a desire for higher compensation, it cannot account for the form that such compensation takes. The exemption amount begins to be phased out when AMTI exceeds a threshold (0,000 for a married individual filing a joint return; 2,500 for a single individual). The deferral of the income inclusion for an ISO is an adjustment in computing AMTI, resulting in the addition to regular taxable income in the tax year in which the option is exercised of an amount equal to the difference between the fair market value of the shares and the exercise price of the option.
The first step in untangling the causes of backdating is to acknowledge that the backdating phenomenon must be driven by both supply and demand factors. Lipman, Incentive Stock Options and the Alternative Minimum Tax: The Worst of Time, 39 Harv. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub.
From the supply side, the question is what motivates a firm to grant a backdated option, and from the demand side, what motivates an executive to demand (or, at the very least, accept) a backdated option?
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The question of demand requires consideration of what an executive receives in monetary value from a backdated option (i.e., an option that appears to be an at-the-money option with an earlier grant date but is, in fact, in-the-money on the actual grant date) compared to a currently dated at-the-money option.