Many commentators were surprised by the recent federal court of claims decision to deny summary judgment in Sutardja v United States. Sutardja, which currently is headed for trial, involves the IRS assessing a public company executive with Code Section 409A penalties, including a 20% additional income tax plus interest, with respect to potentially discounted stock options. What’s surprising isn’t so much the court’s decision, but that the IRS chose this particular fact pattern to assess Code Section 409A penalties. The option grant procedures that the employer followed would not be confused with best practices, but they occurred before Code Section 409A was enacted. The executive and the employer even tried to correct the issue after Code Section 409A’s enactment, despite there being limited other guidance, but the IRS still chose to punish the executive.

We believe that Sutardja offers a couple of lessons for employers. The first is don’t panic—in most cases, executives will still be able to exercise their options when they see fit and thus retain the flexibility to choose when to recognize taxable income. The second is that in order to grant options that provide this type of flexibility, employers need to follow detailed stock option grant requirements under the Code Section 409A regulations. This lesson may be harsh for the executive in Sutardja considering that most of those requirements hadn’t been written yet, but it gives the rest of us a chance to learn from those mistakes. Accordingly, this blog will focus on the opportunities employers have to correct outstanding plan grants and improve grant practices for future grants. We first will provide background on the case itself, highlighting the option grant practices that the IRS punished. Second, we will explain how employers can comply with the stock option grant requirements of Code Section 409A so that executives may retain the flexibility to choose when to exercise those options.