Stock Options - Grant Date (409A and Beyond)

Identifying the “grant date” of a stock option is critical because 409A penalties generally apply to stock options having an exercise price below the fair market value (FMV) of the underlying shares as of the grant date. In contrast, a 409A exemption is potentially available if the exercise price equals or exceeds the FMV of the underlying shares as of the grant date.  When a grant occurs is addressed in Treas. Reg. §1.409A-1(b)(5)(vi)(B), which is reproduced in full below. Here are its four key sentences, followed in bullets by comments about related tax and accounting implications:

1.       “The language the date of grant of the option, and similar phrases, refer to the date when the granting corporation completes the corporate action necessary to create the legally binding right constituting the option.”

  • State law governs when legally binding rights arise. In February 2013, the Federal Court of Claims looked to California law in Sutardja v. U.S. (2/27/2013) in making the first decision focused on an IRS assessment of 409A penalties for discounted stock options.  The court explained as follows: “Although this case is one of federal taxation, courts look “initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach.” Drye v. United States, 528 U.S. 49, 51 (1999).” 


2.       “A corporate action creating the legally binding right constituting the option is not considered complete until the date on which the maximum number of shares that can be purchased under the option and the minimum exercise price are fixed or determinable, and the class of underlying stock and the identity of the service provider is designated.”

  • Under general tax and accounting rules and in stock option litigation, the “grant” of a stock option generally requires a meeting of the minds establishing, at a minimum, the number of shares subject to an option and the exercise price.
  • For incentive stock options and ESPP awards, Treas. Reg. §1.421-1(c) provides that the date of grant for a stock option is the date on which “the granting corporation completes the corporate action constituting an offer of stock . . . [and such corporate action] is not considered complete until the date on which the maximum number of shares that can be purchased under the option and the minimum option price are fixed or determinable.”
  • Under Generally Accepted Accounting Principles, the measurement date of a stock option grant is defined as "the first date on which are known both: (1) the number of shares that an individual employee is entitled to receive and (2) the option or purchase price, if any.” In re Finisar Corp. Derivative Litig., 2009 U.S. DST. LEXIS 94002 (N.D. Cal. Sept. 22, 2009). See the general discussion under “Grant Date” in Section 1.9.1 of this PwC Guide to Share-based Accounting. 
  • In a letter dated 9/19/2006, the SEC’s Chief Accountant addressed when an option is granted, and stated as follows: “If a company operated as if the terms of its awards were not final prior to the completion of all required granting actions (such as by retracting awards or changing their terms), the staff believes the company should conclude that the measurement date for all of its awards (including those awards that were not changed) would be delayed until the completion of all required granting actions.
  • On the other hand, in certain instances where a company’s facts, circumstances, and pattern of conduct evidence that the terms and recipients of a stock option award were determined with finality on an earlier date prior to the completion of all required granting actions, it may be appropriate to conclude that a measurement date under Opinion 25 occurred prior to the completion of these actions.
  • The standards under the § 421 and § 409A regulations are more stringent than the accounting standards as described in the SEC staff letter, because the regulations require the completion of all required corporate granting actions.”
  • The above is cited in a 2009 IRS chief counsel memo re option grant dates for Code 162(m) purposes -http://www.irs.gov/pub/irs-utl/am2009006.pdf. See Paul Hastings 2006 client alert re SEC articulation of the same standard.
  • In Sutardja v. U.S. (noted in #1 above), the Federal Court of Claims echoed the above: “California law establishes that vested options give the optionee the legally binding right to purchase shares at a designated price.”


3.     “Ordinarily, if the corporate action provides for an immediate offer of stock for sale to a service provider, or provides for a particular date on which such offer is to be made, the date of the granting of the option is the date of such corporate action if the offer is to be made immediately, or the date provided as the date of the offer, as the case may be.”

  • FASB’s GAAP rules for share-based accounting include ASC 718-10-25-5 (reproduced in full below), which provides guidance on the determination of an option’s grant date for accounting purposes. This rule allows grantors of options to presume a grant date occurs when the grant receives corporate approval if: (1) the employee receiving the award does not have the ability to negotiate the award and (2) the key terms and conditions of the award are expected to be communicated to all employees receiving awards within a relatively short time period. 
  • ASC 718-10-25-5(b) provides that “a relatively short time period” should, according to the PwC Accounting Guide, be determined based on the period during which an entity could reasonably complete the actions necessary to communicate the terms of an award to the recipients in accordance with the entity’s customary human resource practices. 


4.      “However, an unreasonable delay in the giving of notice of such offer to the service provider will be taken into account as indicating that the corporation provided that the offer was to be made at the subsequent date on which such notice is given.”

  • See note under #3 re the need to communicate award terms to an award recipient within a short time after it receives corporate approval.


NOTE:  When the grant date for an option is uncertain for financial accounting or tax purposes, consider obtaining a legal memorandum to document applicable law and to provide an assessment based on relevant facts.  Financial auditors generally accept and rely on such an assessment, and it would serve to support the reasonableness of a company's tax positions in the event of an IRS audit.

 * * *

1.409A-1(b)(5)(vi)(B) Date of grant of option.

(1)  The language the date of grant of the option, and similar phrases, refer to the date when the granting corporation completes the corporate action necessary to create the legally binding right constituting the option. A corporate action creating the legally binding right constituting the option is not considered complete until the date on which the maximum number of shares that can be purchased under the option and the minimum exercise price are fixed or determinable, and the class of underlying stock and the identity of the service provider is designated. Ordinarily, if the corporate action provides for an immediate offer of stock for sale to a service provider, or provides for a particular date on which such offer is to be made, the date of the granting of the option is the date of such corporate action if the offer is to be made immediately, or the date provided as the date of the offer, as the case may be. However, an unreasonable delay in the giving of notice of such offer to the service provider will be taken into account as indicating that the corporation provided that the offer was to be made at the subsequent date on which such notice is given.

(2)  If the corporation imposes a condition on the granting of an option (as distinguished from a condition governing the exercise of the option), such condition generally will be given effect in accordance with the intent of the corporation. However, if the grant of an option is subject to approval by stockholders, the date of grant of the option will be determined as if the option had not been subject to such approval. A condition that does not require corporate action, such as the approval of, or registration with, some regulatory or government agency, for example, a stock exchange or the Securities and Exchange Commission, is ordinarily considered a condition upon the exercise of the option unless the corporate action clearly indicates that the option is not to be granted until such condition has been satisfied.

(3)  In general, a condition imposed upon the exercise of an option will not operate to make ineffective the granting of the option. For example, on June 1, 2008, Corporation A grants to X, an employee, an option to purchase 5,000 shares of the corporation's common stock, exercisable by X on or after June 1, 2009, provided X is employed by the corporation on June 1, 2009, and provided that A's profits during the fiscal year preceding the year of exercise exceed $200,000. Such an option is granted to X on June 1, 2008, and will be treated as outstanding as of such date. 

* * *

Determining the Grant Date

718-10-25-5 As a practical accommodation, in determining the grant date of an award subject to this Topic, assuming all other criteria in the grant date definition have been met, a mutual understanding of the key terms and conditions of an award to an individual employee shall be presumed to exist at the date the award is approved in accordance with the relevant corporate governance requirements (that is, by the Board or management with the relevant authority) if both of the following conditions are met:

 a. The award is a unilateral grant and, therefore, the recipient does not have the ability to negotiate the key terms and conditions of the award with the employer.

 b. The key terms and conditions of the award are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. A relatively short time period is that period in which an entity could reasonably complete all actions necessary to communicate the awards to the recipients in accordance with the entity's customary human resource practices.

ExecutiveLoyalty.org