Modyfikacja motywacji opcje na akcje

Posiadacze opcji na akcje zachęcające: bądź ostrożny, lub utracisz korzystne traktowanie o podatku dochodowym. 20 grudnia 2017 r. Przez Janice Eiseman, JD, LLM Szczegółowe zasady dotyczące opcji na akcje motywacyjne, zwane również normami ISO, ustawowymi wariantami lub kwalifikowanymi wariantami, muszą być starannie przestrzegane w celu uzyskania korzystnego sposobu opodatkowania osób, które oferują. Korzystne traktowanie polega na tym, że jednostka nie ma dochodu w roku wykonywania, nawet jeśli godziwa wartość rynkowa zapasów podczas wykonywania przekracza cenę wykonania ISO (ldquospreadrdquo). I. R.C. sekcja 421 (a) (1). Zasady odroczonego wynagrodzenia w ramach kodeksu Kod 409A nie mają zastosowania do ISO. Treas. Reg. sekwencja 1.409A-1 (b) (5) (ii). Ponadto osoba ta nie będzie podlegać ustawodawstwu federalnego ubezpieczenia od składek (FIA) ani podatków federalnych o podatku od osób bezrobotnych (FUTA). I. R.C. sekwencja 3121 (a) (22) amp 3306 (b) (19). Jednakże korzystne traktowanie podatku dochodowego nie jest brane pod uwagę dla alternatywnego minimalnego podatku. I. R.C. sekcja 56 (b) (3). W przeciwieństwie do pozytywnych konsekwencji podatkowych osób prywatnych, pracodawcy nie otrzymują odpisu z tytułu korzystania z ISO. I. R.C. sekta 421 (a) (2). Począwszy od 2017 r. Pracodawcy muszą złożyć formularz 3921 z IRS informujący o przekazaniu akcji swoim pracownikom podczas wykonywania swoich norm ISO i przekazują pracownikom kopie formularza 3921. I. R.C. sekta 6039 amp Treas. Reg. sekwencja 1.6039-1 (a) amp (2) (a). Pomimo tego, że opcja spełnia wymagania ISO określone w kodzie 422 (b) w dniu przyznania, po dacie dotacji należy korzystać z wielu świadczeń przyznawanych przez ISO. Po pierwsze, z zastrzeżeniem pewnych wyjątków, przeniesienie zapasów na osobę fizyczną podczas wykonywania ich ISO nie będzie wolne od podatku, chyba że w każdym czasie w okresie rozpoczynającym się w dniu przyznania ISO i kończącym się w dniu trzy miesiące przed datą w ramach ISO, osoba ta była pracownikiem korporacji udzielającej opcji lub lquiregowanej korporacji, rdquo tj. rodzicem lub spółką zależną korporacji pracodawcy, jak określono w sekcjach 424 lit. e) i f). I. R.C. sekta 422 (a) (2). Tak więc, jeśli dana osoba zakończyła pracę stałą w dniu 30 czerwca, muszą one wykonywać swoje obowiązki w okresie do 30 września w celu zaspokojenia reguły ciągłej pracy. (Data zakończenia zatrudnienia jest wyłączona, a ostatni dzień okresu jest wliczony w cenę Rev. Rut 66-5, 1966-1 CB 91.) Jeśli zasada "nieudokumentowania" zatrudnienia nie jest spełniona, spread będzie stanowił wynagrodzenie podlegające podatków dochodowych i związanych z zatrudnieniem oraz związanego z tym podatku dochodowego. Istnieją pewne wyjątki od tej reguły. Jeśli osoby kończą pracę z powodu niepełnosprawności, mają one rok od rozwiązania umowy, aby móc korzystać z ISO. I. R.C. sekcja 422 (c) (6). Jeśli umrą w trakcie zatrudnienia lub w ciągu trzech miesięcy od zakończenia zatrudnienia, dodatkowy czas jest dozwolony dla korzystania z ISO, o ile plan ISO i umowa pozwolą na dodatkowy czas. Treas. Reg. sekta 1.421-2 (c). Pewne przerwy w stosunkach pracy, np. urlop wojskowy, nie będzie uznawany za przerwy w nieprzerwanym zatrudnieniu. Treas. Reg. sek 1.421-1 (h) (2). Oprócz wymogu dotyczącego zatrudnienia i pracy na rytm biegu, osoby fizyczne muszą spełniać wymóg posiadania okresu w celu uzyskania bezpłatnego traktowania w trakcie wykonywania swoich norm ISO. Zgodnie z wymogiem okresu utrzymywania, osoba ta musi przechowywać czas przez co najmniej dwa lata od daty przyznania opcji i jednego roku od daty przeniesienia zapasów do nich. I. R.C. sekcja 422 (a) (1). Jeśli dana osoba dokona dystrybucji swoich zasobów ISO w tym okresie, dokonali ldquodisqualifying dispositionrdquo zapasów. Zasadniczo dyskwalifikacja dispositionrdquo ogólnie oznacza, że ​​osoba fizyczna musi rozpoznać zwykłe dochody w ramach kodeksu 83 w roku dyspozycyjnym równym spreadowi. Treas. Reg. sekta 1.421-2 (b). Taki zwykły dochód jest dodawany do bazy zapasowej w celu określenia zysku kapitałowego wynikającego z dyskwalifikującego usposobienia. Korporacja pracodawców będzie uprawniona do potrącenia równego spreadowi. I. R.C. sekta 421 (b). Pomimo, że doszło do dyskryminacji, to jednak zwykłe dochody generowane przez takie usposoby nie podlegają opodatkowaniu podatkiem od pracy lub podatkiem dochodowym. I. R.C. sekta 421 (b). Należy jednak pamiętać, że jeśli cena dyspozycyjna jest niższa niż cena akcji w dniu wykonania, to dyspozycja jest transakcją, w której strata, jeśli zostanie utrzymana, zostanie uznana, np. sprzedaż nie jest sprzedażą lub wymianą na rzecz osoby powiązanej na podstawie przepisów kodeksu 267 (a) (1), wówczas kwota zwykłego dochodu uznana przez osoby fizyczne (i potrącenie pobierane przez korporację pracodawców) nie jest spreadem, ale różnica pomiędzy kwotą zrealizowaną w wyniku sprzedaży lub wymiany a podstawą magazynu. I. R.C. sekcja 422 (c) (2). ISO, które są modyfikowane lub przenoszone Transfery, które nie stanowią ldquodispositions, rdquo są wymienione w kodzie 424 (c) kodu. Na przykład przeniesienie inwazji produktów ISO do rozwodu nie będzie stanowiło ldquodisposition, a małżonek otrzymujący towar ISO będzie uprawniony do takiego samego opodatkowania co pracownik. I. R.C. sekcja 424 (c) (4) Treas. Reg. sekcja 1.424-1 (c) (1) (iv). Należy jednak pamiętać, że jeśli sam ISO zostanie przeniesiony na wypadek rozwodu, opcja traci jego status ISO na dzień takiego przeniesienia. Treas. Reg. sekcja 1.421-1 (b) (2). ISO może przestać być ustawową opcją, jeśli zostanie zmodyfikowana. Reguły dotyczące czasu uznania ISO za ldquomodifiedrdquo są bardzo trudne. Z zastrzeżeniem pewnych wyjątków określonych w kodeksie 424 (h) (3), ldquomodificationrdquo definiuje się jako zmianę, co zapewnia dodatkowe korzyści. I. R.C. 424 (h) (3) Treas. Reg. sekcja 1.424-1 (e) (4) (i). Jeśli system ISO zostanie uznany za zmodyfikowany, przedłużony lub odnowiony na mocy przepisów kodeksu 424 (h) i rozporządzenia w sprawie skarbb (sekcja 1.424-1 lit. e), wówczas uważa się, że osoby fizyczne otrzymały nową opcję, która może lub nie spełnia wymagań definicji ISO. Na przykład powiedzmy, że pracownik wykonujący swoją firmę ISO chce skorzystać z rozłożenia i wykorzystać nabyte wcześniej zapasy, aby zapłacić cenę wykonania. Podczas gdy ich umowa ISO nie stwierdza, że ​​korzystanie ze skupu nabytego wcześniej jest metodą płatności, zapewnia, że ​​cena wykonania może być wypłacona dowolną inną metodą zatwierdzoną przez komitet opcjonalny. Jeśli pracownik użyje wcześniej nabytych zasobów, ich ISO zostanie ldquomodified. rdquo Treas. Reg. sekcja 1.424-1 (e) (4) (i). W przeciwieństwie do tego, jeśli wcześniej nabyte akcje zostały wymienione jako metoda płatności, która może być wykorzystana według uznania komisji opcji, nie byłoby modyfikacji. Treas. Reg. sekcja 1.424-1 (e) (4) (iii). Jeśli w rzeczywistości pracownik korzysta z wcześniej nabytego zapasu, ich ldquonew optionrdquo nie będzie spełniał definicji ISO z powodu rozprzestrzeniania się, co spowoduje, że pracownik ma zwykłe dochody podczas ćwiczeń i podlega opodatkowaniu i podatku od pracy. ldquoModificationrdquo kwestie pojawiają się również, gdy nastąpiło założenie lub zastąpienie ISO w transakcji ldquocorporate, rdquo zgodnie z definicją w rozporządzeniu dotyczącym Skarbu Państwa sekcja 1.424-1 (a) (3), np. fuzji lub reorganizacji. Pod warunkiem, że spełnione są zasady określone w kodeksie 424 (a) i rozporządzeniu skarbowym (sekcja 1.424-1 (a), transakcja ldquocorporate transakcji nie spowoduje ldquomodificationrdquo założonej lub zastępczej normy ISO. Zauważ, że zasady dotyczące modyfikacji ISO zgodnie z kodeksem kodów 409A, opisane w sekcji 1.409A-1 lit. b) (5) (v) skarbu państwa, nie są identyczne z regułami określonymi w kodeksie 424 i rozporządzeniu skarbowym w sekcji 1.424 -1 (e). ISO zapewnia pracownikom wysokie korzyści podatkowe. Aby jednak uzyskać te zalety podatkowe, należy przestrzegać zasad ISO. W tym artykule podkreślono tylko niektóre z tych zasad i na pewno nie omawiano ich wszystkich. Podobne artykuły Pomocne produkty26 Kod USA 422 - Opcje na akcje motywacyjne Opcje na akcje motywacyjne (a) Ogólnie w art. 421 lit. a) stosuje się w odniesieniu do przeniesienia udziału w akcji na rzecz osoby fizycznej w ramach korzystania z opcji na akcje motywacyjne, jeśli nie zbycie udziałów nastąpi w ciągu 2 lat od dnia udzielenia opcji, ani w ciągu roku od dnia przekazania mu takiego udziału, a przez cały czas w okresie rozpoczynającym się z dniem przyznania opcji a kończąc na dzień 3 miesiące przed datą takiego wykonywania, osoba ta była pracownikiem albo korporacji nadającej taką opcję, spółce dominującej lub zależnej takiej korporacji, albo korporacji lub rodzicom lub spółkom zależnym takiej spółki emitującej lub przy założeniu opcji na akcje w transakcji, do której ma zastosowanie sekcja 424 (a). b) Opcja akcji motywacyjnej Dla celów niniejszej części termin "zasiłek motywacyjny" oznacza opcję przyznaną osobie z jakiegokolwiek powodu związaną z jego zatrudnieniem przez korporację, jeśli została przyznana przez korporację pracodawców lub jej spółkę dominującą lub spółkę zależną, na nabycie zapasów takich korporacji, ale tylko wtedy, gdy opcja jest przyznawana zgodnie z planem, który obejmuje łączną liczbę akcji, które mogą być wyemitowane w ramach opcji i pracowników (lub kategorii pracowników) uprawnionych do otrzymania opcji, które zostały zatwierdzone przez akcjonariusze korporacji udzielającej koncesji w ciągu 12 miesięcy przed lub po dniu, w którym przyjęty został taki plan, taka opcja jest przyznawana w ciągu 10 lat od daty przyjęcia takiego planu lub datę zatwierdzenia planu przez akcjonariuszy, w zależności od tego, która z tych opcji jest wcześniej taka możliwość jego warunki nie mogą być wykonalne po upływie dziesięciu lat od daty przyznania takiej opcji, cena opcji nie jest mniejsza od wartości godziwej rynku w chwili taka opcja jest przyznana temu warunkom, nie może być przenoszona przez tę osobę w inny sposób niż wola lub prawa zejcia i dystrybucji, a wykonywanie w trakcie jego trwania wyłącznie przez niego i takiej osoby, w momencie przyznania opcji, nie posiada akcji posiadających więcej niż 10 procent łącznej łącznej liczby głosów wszystkich klas zapasów korporacji pracodawcy lub jej spółki macierzystej lub spółki zależnej. Okres ten nie obejmuje żadnej opcji, jeżeli (od momentu udzielenia opcji) warunki tej opcji nie stanowią, że będą one traktowane jako opcja motywacyjna. c) Zasady specjalne (1) Wysiłek wiary w wartość zapasów Jeżeli część udziałów zostanie przeniesiona w ramach wykonywania przez osobę fizyczną opcji, która nie kwalifikuje się jako opcja motywacyjna na akcje w ramach podsekcji (b), ponieważ nie było nieprzygotowanie w dobrej wierze spełnienia wymogu podrozdziału (b) (4), wymóg podsekcji (b) (4) uznaje się za spełniony. W zakresie przewidzianym w przepisach przez Sekretarza, podobnie stosuje się reguły podobne do celów podsekcji (d). (2) Niektóre dyskwalifikacje, w których zrealizowana kwota jest niższa od wartości w trakcie wykonywania czynności Jeśli osoba, która nabyła akcję w wyniku skorzystania z opcji na akcje motywacyjne, dokonuje zbycia takiego udziału w jednym z okresów opisanych w podpunkcie a) (1), a takie usposobienie jest sprzedażą lub wymianą, w odniesieniu do których taka osoba otrzyma stratę (jeśli jest utrzymana), to kwota, która jest wliczona w dochód brutto takiej osoby, a kwota, która jest odliczana od dochód korporacji pracodawcy, ponieważ odszkodowanie z tytułu korzystania z takiej opcji nie przekracza nadwyżki (jeśli w ogóle) kwoty zrealizowanej w wyniku takiej sprzedaży lub wymiany na podstawie skorygowanej podstawy takiej części. (3) Pewne przelewy przez niewypłacalne osoby Jeżeli niewypłacalna osoba posiada udział w akcjach nabytych w wyniku skorzystania z opcji na akcje motywacyjne, a jeśli taki udział zostanie przekazany powiernikowi, odbiorcy lub innemu podobnemu powiernikowi w postępowaniu w ramach tytułu 11 lub w inny podobny sposób postępowania upadłościowego, ani takie przeniesienie, ani jakikolwiek inny transfer takiego udziału na korzyść wierzycieli w toku postępowania stanowi zbycie takiego udziału w celach podsekcji (a) (1). (4) Dopuszczalne postanowienia Opcja, która spełnia wymagania podpunktu b) traktowana jest jako opcja motywacyjna, nawet jeśli pracownik może zapłacić za zapas akcji korporacją przyznającą opcję, pracownik ma prawo do otrzymania nieruchomości w momencie skorzystania z opcji, lub opcja podlega warunkom niezgodnym z postanowieniami podsekcji (b). Akapit (B) stosuje się do przeniesienia własności (innej niż gotówka) tylko wtedy, gdy sekcja 83 ma zastosowanie do tak przekazanej nieruchomości. (5) 10-procentowa zasada dla akcjonariuszy Podsekcja b) pkt 6 nie ma zastosowania, jeżeli w momencie przyznania takiej opcji cena opcji wynosi co najmniej 110 procent wartości godziwej na akcje oparte na opcji, a opcja taka jego warunki nie mogą być wykonalne po upływie 5 lat od daty przyznania takiej opcji. (6) Zasada szczególna, gdy jest niezdolna Do celów ustępu (a) (2), w przypadku pracownika niepełnosprawnego (w rozumieniu sekcji 22 (e) (3)) trzymiesięczny okres podsekcji ( a) (2) wynosi 1 rok. (7) Uczciwa wartość rynkowa Dla celów niniejszej sekcji godziwa wartość rynkowa zapasów jest ustalana bez względu na ograniczenia inne niż ograniczenie, które w ujęciu jego nie wygaśnie. d) Ograniczenie w wysokości 100 000 na rok W zakresie, w jakim łączna wartość godziwej rynkowej akcji, w odniesieniu do której opcje na akcje motywacyjne (ustalone bez uwzględnienia niniejszego podrozdziału) są wykonywane przez każdą osobę w danym roku kalendarzowym po raz pierwszy (we wszystkich planach korporacji pracodawców indywidualnych oraz ich spółek macierzystych i zależnych) przekracza 100 000, takie opcje są traktowane jako opcje, które nie są wariantami motywacyjnymi. (2) Zasada zamó wienia § 1 stosuje się biorąc pod uwagę opcje w kolejności, w jakiej zostały przyznane. (3) Określenie wartości godziwej rynkowej Do celów ust. 1 wartość godziwa każdego zapasu ustalana jest z chwilą przyznania opcji w odniesieniu do takiego zapasu. Subsec. (c) (5) do (8). Pub. L. 101508. 11801 (c) (9) (C) (ii), przeprojektowane parsy. (6) do (8) odpowiednio jako (5) do (7), i uderzyły w poprzedni par. (5) Koordynacja z sekcjami 422 i 424, które brzmi następująco: Sekcje 422 i 424 nie mają zastosowania do opcji na akcje motywacyjne. 1988Subsec. (b). Pub. L. 100647. 1003 (d) (1) (A), wstawione na końcu Określenie to nie obejmuje żadnej opcji, jeżeli (w momencie udzielenia opcji) warunki takiego wyboru stanowią, że nie będą traktowane jako opcja akcje motywacyjne. Subsec. (b) (7). Pub. L. 100647. 1003 (d) (2) (B), o których mowa w ust. (7), które brzmi następująco: zgodnie z planem, łączna wartość godziwa rynkowa (określona w momencie przyznania opcji) zapasów, w odniesieniu do których opcje te są realizowane po raz pierwszy przez tę osobę podczas w każdym roku kalendarzowym (w ramach wszystkich takich planów korporacji pracodawców indywidualnych oraz jej spółek macierzystych i zależnych) nie przekracza 100 000. Subsec. (c) (1). Pub. L. 100647. 1003 (d) (2) (C), podstawiona podsekcja (d) w ustępie 7 ustępu (b). 1986Subsec. (b) (7). Pub. L. 99514. 321 (a), dodany par. (7) i uderzył w poprzednią par. (7), które brzmi następująco: opcja ta nie jest wykonalna, gdy nie ma w niej znaczenia (w rozumieniu podsekcji c) (7) dowolnej opcji na akcje motywacyjne, która została przyznana, przed udzieleniem takiej opcji, takim indywidualnie do nabycia akcji w jego korporacjach pracodawców lub w korporacji, która (w momencie udzielania takiej opcji) jest spółką dominującą lub zależną korporacji pracodawcy lub w poprzedniej korporacji jakiejkolwiek z takich korporacji i. Subsec. (b) (8). Pub. L. 99514. 321 (a), wypchnięty par. (8), które brzmi następująco: w przypadku opcji przyznanej po 31 grudnia 1980 r. Zgodnie z planem łączna wartość godziwa rynkowa (ustalona w momencie udzielenia opcji) zapasów, dla których każdy pracownik w dowolnym roku kalendarzowym (w ramach wszystkich takich planów jego korporacji pracodawców i jej spółek macierzystych i zależnych) nie może przekroczyć 100 000 plus wszelkie niewykorzystane przeniesienie wartości granicznych w tym roku. Subsec. (c) (1). Pub. L. 99514. 321 b) ustęp 2 akapit 7 ustępu 7 podsekcji b) dla ustępu 8 ustępu b) i ustępu 4 niniejszego podsekcji. Subsec. (c) (4). Pub. L. 99514. 321 (b) (1), redesignated par. (5) jako (4) i uderzył w poprzedni par. (4) dotyczące przeniesienia niewykorzystanego limitu. Subsec. (c) (5), (6). Pub. L. 99514. 321 (b) (1) (B), przeprojektowane parsy. (6) i (8) odpowiednio (5) i (6). Były par. (5) przebudowany (4). Subsec. (c) (7). Pub. L. 99514. 321 (b) (1), redesignated par. (9) jako (7) i uderzył w poprzednią par. (7), które przewidywały, że dla celów subsec. (b) (7) dowolna opcja na akcje motywacyjne traktowana jest jako pozostająca do spłaty, dopóki taka opcja nie zostanie wykonana w całości lub wygasła z powodu upływu czasu. Subsec. (c) (8). Pub. L. 99514. 321 (b) (1) (B), redesignated par. (10) jako (8). Były par. (8) przeprojektowany (6). Subsec. (c) (9). Pub. L. 99514. 321 (b) (1) (B), redesignated par. (9) jako (7). Pub. L. 99514. 1847 (b) (5), podstawiona sekcja 22 (e) (3) dla sekcji 37 (e) (3). Subsec. (c) (10). Pub. L. 99514. 321 (b) (1) (B), redesignated par. (10) jako (8). 1984Subsec. (c) (9). Pub. L. 98369. 2662 (f) (1), podstawiona sekcja 37 (e) (3) dla sekcji 105 (d) (4). 1983Subsec. (b) (8). Pub. L. 97448. 102 (j) (1), podstawione przyznane opcje motywacyjne dla przyznanych opcji. Subsec. (c) (1). Pub. L. 97448. 102 (j) (2), podstawiona Dobra wiara w celu wyceny zapasów do realizacji opcji, gdy cena jest niższa niż wartość zapasów w par. 1) nagłówek i dodane sankcje, pod warunkiem, że w zakresie przewidzianym w przepisach Sekretarza, przepis podobny do tego, który został już wymieniony w ustępie, ma zastosowanie do celów ust. (8) podsieci. (b) i par. (4) podsieci. (do). Subsec. (c) (2) (A). Pub. L. 97448. 102 (j) (3), zastąpione jednym z okresów na okres 2 lat. Subsec. (c) (4) (A) (ii). Pub. L. 97448. 102 (j) (4), podstawione przyznane opcje motywacyjne dla przyznanych opcji. Obowiązuje od 1988 r. Poprawkę złożył Pub. L. 100647 skuteczne, o ile nie przewidziano inaczej, tak jakby zostało to ujęte w ustawie o reformie podatkowej z 1986 r., Pub. L. 99514., do którego odnosi się taka poprawka, zob. Sekcję 1019 lit. a) Pub. L. 100647. określono jako notatkę w sekcji 1 niniejszego tytułu. Data wejścia w życie z 1986 r. Poprawki wprowadzone w tej sekcji zmieniającej ten punkt stosuje się do opcji przyznanych po 31 grudnia 1986 r. Zmiana w sekcji 1847 lit. B) ust. 5 Pub. L. 99514 są skuteczne, o ile nie postanowiono inaczej, tak jakby zostały zawarte w ustawie o reformie podatkowej z 1984 r., Pub. L. 98369, div. A., którego dotyczy poprawka, zob. Sekcja 1881 Pub. L. 99514. przedstawiony jako notatkę w sekcji 48 niniejszego tytułu. Data wejścia w życie z 1984 r. Poprawka wprowadzona w ustępie a) (1) zmieniająca niniejszą sekcję stosuje się do opcji przyznanych po 20 marca 1984 r., Z wyjątkiem tego, że taki podsekcji nie ma zastosowania do dowolnej opcji na akcje motywacyjne przyznanej przed dniem 20 września 1984 r. do planu przyjętego lub korporacyjnego podjętych przez zarząd koncernu grantodawców przed dniem 15 maja 1984 r. Zmiana w sekcji 2662 Pub. L. 98369 skuteczne, jakby zostało ujęte w poprawkach o zabezpieczenie społeczne z 1983 r., Pub. L. 9821. patrz sekcja 2664 lit. a) Pub. L. 98369. określono jako notatkę w sekcji 401 tytułu 42. Zdrowie publiczne i opieka społeczna. Skuteczna data z 1983 r. Poprawkę złożył Pub. L. 97448 są skuteczne, z wyjątkiem przypadków przewidzianych w inny sposób, tak jakby zostały uwzględnione w przepisach o podatku dochodowym od osób fizycznych z 1981 r., Pub. L. 9734. do którego odnosi się poprawka, zob. Sekcja 109 Pub. L. 97448. określono jako notatkę w sekcji 1 niniejszego tytułu. (1) Opcje, do których sekcja ma zastosowanie. Z wyjątkiem przypadków przewidzianych w ustępie (B) poprawki dokonane przez niniejszą sekcję obowiązującą w tej sekcji oraz nowelizujące sekcje 421, 425 i 424 oraz 6039 niniejszego tytułu mają zastosowanie w odniesieniu do opcji przyznanych w dniu 1 stycznia 1976 r. I później i będą wykonywane na lub po 1 stycznia 1981 r. lub pozostały do ​​spłaty w tym terminie. (B) Wybory i wyznaczenie opcji. W przypadku opcji przyznanej przed dniem 1 stycznia 1981 r. Zmiany dokonane w niniejszej sekcji stosuje się tylko wtedy, gdy korporacja przyznająca taką opcję wybiera (w sposób iw terminie określonym przez Sekretarza Skarbu Państwa lub jego delegata) zmiany tej sekcji mają zastosowanie do takiej możliwości. Łączna wartość godziwa rynkowa (ustalona w czasie przyznania opcji) w odniesieniu do zapasów, w odniesieniu do których pracownik otrzymał opcje (na podstawie wszystkich planów jego korporacji pracodawców i jej spółek dominujących i zależnych), do których mają zastosowanie poprawki wprowadzone przez niniejszą sekcję, z tego powodu akapit nie może przekroczyć 50 000 w roku kalendarzowym i nie przekracza 200 000 w skali zagregowanej. (2) Zmiany w wariantach. W przypadku opcji przyznanej w dniu 1 stycznia 1976 r. Lub po tej dacie, a nie spłaconym w dniu uchwalenia ustawy z dnia 13 sierpnia 1981 r., Ust. 1 pkt 425 lit. h) Kodeksu dochodów Własnościowych z 1986 r. IRC 1954 nie ma zastosowania do każdej zmiany warunków takiej opcji (lub warunków planu, w ramach którego udzielono, w tym zatwierdzenia akcjonariuszy), dokonanego w ciągu 1 roku od daty jego wejścia w życie, aby umożliwić taką opcję kwalifikację jako opcję motywacyjnego. Dla przepisów, które nic w poprawce Pub. L. 101508 można interpretować jako wpływające na traktowanie niektórych transakcji, nabytych nieruchomości lub pozycji dochodów, strat, potrącenia lub kredytu uwzględnionych przed 5 listopada 1990 r. W celu określenia odpowiedzialności za podatek za okresy kończące się po listopadzie 5, 1990. zob. Sekcja 11821 lit. b) Pub. L. 101508. określono jako notatkę w sekcji 45K niniejszego tytułu. Likwidacja opcji jako opcji motywacyjnych W przypadku opcji przyznanej po 31 grudnia 1986 r. Oraz w dniu lub przed dniem uchwalenia ustawy z 10 listopada 1988 r. Taka opcja nie może być traktowana jako opcja motywacyjna, jeśli warunki takiego wariantu zostaną zmienione przed upływem 90 dni od daty jego wejścia w życie, aby zapewnić, że taka opcja nie będzie traktowana jako opcja motywacyjna. Zmiany w planie nie są wymagane Do dnia 1 stycznia 1989 r. W przypadku przepisów przewidujących, że w przypadku wprowadzenia jakichkolwiek poprawek pod tytułem A lub podtytuł C tytułu XI 11011147 i 11711177 lub tytułu XVIII 18001899A Pub. L. 99514 wymagają zmiany jakiegokolwiek planu, taka zmiana planu nie będzie wymagana przed pierwszym rokiem, rozpoczynającym się w dniu 1 stycznia 1989 r. Lub później. Patrz sekcja 1140 Pub. L. 99514 z późniejszymi zmianami, określonymi w uwadze 401 niniejszego tytułu. Pisemne ustalenia dotyczące tej sekcji Dokumenty te, czasami określane jako orzeczenia w piśmie prywatnym, są pobierane z strony Wyznaczenia pisemne IRS, a IRS publikuje pełniejsze wyjaśnienie tego, czym one są i co oznaczają. Kolekcja jest aktualizowana (na naszym końcu) codziennie. Wygląda na to, że IRS aktualizuje swoją listę każdego piątku. Należy zauważyć, że IRS często określa dokumenty w bardzo prosto-waniliowym, duplikacyjnym sposobie. Nie przypuszczaj, że identyczne tytuły są takie same, lub że późniejszy dokument zastępuje inny o tym samym tytule. To mało prawdopodobne. Daty wydania są dokładnie takie, jak je otrzymujemy od IRS. Niektóre z nich są błędnie, ale nie podjęliśmy prób ich poprawiania, ponieważ we wszystkich przypadkach nie zgadujemy prawidłowo i nie chcemy dodawać do zamieszania. Obniżymy wyniki w 20000 elementach. Po tym, ty sam jesteś. Wydano: 01 grudnia 1997 r. Źródło: Organ podatkowy Rosnące zainteresowanie wśród pracodawców korporacyjnych wzrasta zainteresowanie pracodawcami korporacyjnymi w korzystaniu z opcji motywacyjnych (lub ISO) kwalifikujących się na mocy art. 422 kodeksu dochodów wewnętrznych z 1986 r., Jako (Kodeks) jako część rekompensaty pracowników. Podobnie jak inne typy opcji, ISO zapewnia nagrodę pracownikom związanym bezpośrednio z wartością pracodawcy korporacyjnego, zapewniając pracownikom motywację do poprawy ogólnej wydajności korporacji. Z punktu widzenia pracowników, ISO oferują ogólnie korzystniejsze traktowanie podatkowe niż niekwalifikowane opcje na akcje i inne kompensaty opartych na akcjach, takie jak zapasy zastrzeżone. Jeśli spełnione są konkretne wymogi (opisane poniżej), zysk osiągnięty przez pracownika przy wykonywaniu ISO nie podlega wówczas opodatkowaniu, a zyski nie są rozpoznawane, dopóki akcje nie są sprzedawane lub w inny sposób zbywane. Ponadto, jeśli osoba fizyczna wykonująca ISO posiada akcje nabyte tak długo, aż do śmierci, nadwyżka wartości rynkowej akcji na jego bazie uniemożliwi podatek dochodowy w całości ze względu na podwyższenie podstawy przy śmierci. Jeżeli i kiedy akcje nabyte przez pracownika w wyniku wykonywania ISO są sprzedawane przez tę osobę za kwotę przekraczającą koszty, kwota zrealizowana, pomniejszona o posiadaczy podstawę tych udziałów, jest brana pod uwagę jako zysk kapitałowy, jeśli akcje są aktywa kapitałowe w rękach posiadacza (jak to zwykle ma miejsce). Korporacja pracodawców nie otrzyma potrącenia w związku z dotacją lub w ogóle wykonywania ISO. W porównaniu z planami nabycia akcji pracowniczych, które kwalifikują się do przepisów sekcji 423 Kodeksu i innych uzgodnień w zakresie podatków, ISO zapewnia większą elastyczność, ponieważ nie podlegają minimalnym zasadom uczestnictwa i niedyskryminacji. Tak więc korporacja może kierować przyznawaniem ISO tym pracownikom, którzy są najbardziej cenni lub potrzebują motywacji związanych z wydajnością firmy, a także pracownikom najbardziej prawdopodobnym, że będą korzystać ze specjalnych cech podatkowych ISO. Wśród kilku powodów stają się bardziej atrakcyjne opcje akcji motywacyjnych. Silne wyniki na giełdzie w ciągu ostatniego dziesięciolecia wzbudziły zainteresowanie opcjami na akcje i innymi formami rekompensaty opartej na kapitale. Wydaje się też, że kadra kierownicza wyższego szczebla uważa, że ​​aby poprawić ogólną wydajność działalności, korzyści związane z lepszymi wynikami powinny być dzielone szeroko wśród pracowników, a nie tylko do najbardziej wykształconych kadry kierowniczej. (1) Opcje motywacyjne są atrakcyjne i łatwo zrozumiałe dla menedżerów i innych jako okazję do udziału w rozwoju firmy. Również w porównaniu z wynagrodzeniem opartym na wynikach osiągniętych w gotówce, opcje na akcje nie wpływają niekorzystnie na przepływy pieniężne i generalnie nie znacząco zmniejszają zysków korporacyjnych, obliczonych dla celów księgowych. Wreszcie rosnące stawki podatku od zwyczajnych dochodów w ciągu ostatniej dekady (obecnie zbliżające się do 50 dla niektórych osób w górnych nawiasach, które również podlegają podatkom dochodowym od państwa i lokalnego), w połączeniu z niedawnymi obniżkami stawek podatkowych od zysków kapitałowych i rosnących wyrafinowanie dotyczące środków i potencjalnych korzyści odroczenia uznania zysku na czas nieokreślony znacznie zwiększyło apelację ISO w porównaniu do niekwalifikowanych opcji na akcje - w odniesieniu do których zyski należy wziąć pod uwagę jako zwykły dochód w czasie wykonywania. Przypadek dla ISO jest jeszcze bardziej atrakcyjny dla przedsiębiorców rozpoczynających działalność lub innych przedsiębiorstw nieposiadających obecnie dochodów do opodatkowania lub znacznych strat z tytułu utraty działalności operacyjnej, w przypadku których brak możliwości uzyskania ulgi podatkowej w związku z przyznaniem lub wykonywaniem ISO jest mniejszy. Poniższa część II omówiona poniżej podstawowe zasady dotyczące przyznawania ISO oraz część III omawia pewne wymagania dotyczące korzystania z takich opcji. Część IV opisuje konsekwencje podatkowe związane z wykonywaniem ISO w sposób bardziej szczegółowy, w tym niekorzystne skutki wcześniejszej sprzedaży lub innego sposobu dysponowania zasobami uzyskanymi dzięki wykonywaniu ISO. Wreszcie część V omawia potencjalną dodatkową zaletę polegającą na zapewnieniu planu opcji wykorzystania uprzednio nabytych akcji zapasów pracodawców, aby zapłacić cenę wykonania według ISO i adresuje inne środki ułatwiające pracownikom korzystanie z ISO. II. Wymagania dotyczące kwalifikacji ISO Ograniczone do Pracowników Opcja zakupu na akcje może kwalifikować się jako ISO tylko wtedy, gdy jest przyznawana jednostce w związku z zatrudnianiem osób przez korporację i tylko wtedy, gdy jest udzielona przez korporację pracodawców lub jej spółkę dominującą lub zależną ( to znaczy korporacja w łańcuchu własności, rozpoczynająca się lub kończąca korporacją pracodawcy, z każdą korporacją powiązaną z innymi przez nie mniej niż 50 udziałów w papierach wartościowych, określoną przez prawo głosu). Opcja ta musi przyznać posiadaczowi prawo do zakupu akcji w korporacji pracodawcy lub jej jednostce dominującej lub zależnej. Biorąc pod uwagę wzrastające wykorzystanie przez korporacje spółek z ograniczoną odpowiedzialnością do wspólnych przedsięwzięć, warto zauważyć, że zgodnie z tą zasadą nie można przyznawać pracownika partnerstwa (lub innych podmiotów, takich jak spółki z ograniczoną odpowiedzialnością, które są traktowane jako partnerstwa dla celów podatkowych), nawet jeśli partnerstwo jest kontrolowane przez korporację, która przyjęła lub mogłaby przyjąć plan ISO. Oczekuje się, że przyszłe przepisy prawne poprawią ten widoczny nadzór. Przyjęcie planu akcji Motywacja musi być udzielona zgodnie z planem, który musi zostać zaakceptowany przez akcjonariuszy korporacji przyznających te opcje w ciągu 12 miesięcy przed lub po dacie, w której plan zostanie przyjęty. (2) Plan musi określać łączną liczbę akcji, które można wyemitować w ramach opcji oraz pracowników lub kategorii pracowników uprawnionych do otrzymania opcji. Plan nie musi i zazwyczaj nie określać osób otrzymujących opcje, z tą odpowiedzialnością zwykle przekazuje się osobie lub komisji powołanej zgodnie z planem. Maksymalna długość planu i opcji Każda ISO przyznana w ramach planu musi zostać wydana w ciągu 10 lat od przyjęcia planu, a ISO musi, według jego warunków, być niewykonalne po 10 rocznicy dotacji. (3) Aby kwalifikować się jako ISO, cena wykonania nie może być mniejsza niż wartość godziwa rynkowa zapasów w momencie przyznania opcji. (4) W przypadku akcji w obrocie publicznym wartość godziwa rynkowa może być ustalona poprzez odniesienie do cen rynkowych. Zgodność z tym wymogiem dotyczącym wyceny jest oczywiście trudniejsza, jeśli papier podstawowy nie jest publicznie notowany. Dopóki podejmowana jest próba dobrej wiary w celu spełnienia tego wymogu, wymóg ten zostanie uznany za spełniony, nawet jeśli uczciwa wartość rynkowa akcji podlegających ISO zostanie ostatecznie ustalona na wyższą niż cena wykonania. (5) W związku z tym, w przypadku gdy opcje są emitowane w odniesieniu do akcji niepublicznych, ważne jest, aby w dobrej wierze dokonać wyceny akcji w momencie przyznania opcji (poprzez odniesienie, być może, do formuły wyceny based on a reasonable multiple of earnings or sales), and to maintain records documenting the derivation of fair market value. The ISO must by its terms be nontransferable by the employee except by will or the laws of descent and distribution. (6) Upon an employees death, the ISO may pass under the will or by the laws of intestacy, and the executor of the estate or other distributee may exercise the ISO. In general, an ISO cannot be granted to an individual who, at the time of grant, owns stock having more than 10 of the combined voting power of all classes of stock of the employer corporation or of its parent or subsidiary corporation. Stock ownership attribution rules apply in determining whether an individual is a 10 stockholder. (7) This limitation obviously discourages the adoption of an ISO plan principally for the benefit of employees who are also substantial shareholders. The limitation does not apply, however, to the grant of an option if the exercise price is at least 110 of fair market value of the shares (as determined at the time of grant) and if the option ceases to be exercisable on or before the fifth anniversary of the date of grant. (8) Restriction on Quantity of Shares Subject to ISO Perhaps the most confusing ISO restriction is the limitation, applied on an annual basis, on the number of shares that may be purchased by an employee under options that first become exercisable in a particular year. Specifically, the fair market value of shares with respect to which ISOs may first become exercisable in any one year (under all plans of the employer corporation and its parent and subsidiary corporations) cannot exceed 100,000. (9) To the extent that options otherwise qualifying as ISOs exceed this limitation, the excess options are treated as options which are not ISOs. For purposes of computing the limitation, the fair market value of the stock is determined as of the date the ISO is granted. If the exercise price of each ISO granted under an employers plan is equal to the fair market value of the underlying shares of stock at the time of grant (a common situation, although ISOs with exercise prices in excess of current fair market value are obviously permissible), then compliance with the limit can be tested by comparing 100,000 to the sum, for all of the ISOs of an employee that are first exercisable in a particular year, of the product of (i) the number of shares with respect to which each such ISO becomes exercisable in that year, multiplied by (ii) the exercise price per share. The qualification of an ISO under this restriction can be determined when the ISO is granted, since the fair market value of the shares subject to an ISO at the time of exercise is not relevant to this determination. An example may make this limitation clearer. Assume that, upon the adoption of an ISO plan, the stock of an employer corporation has a fair market value of 20 per share. The corporation may then grant to an employee an ISO, exercisable immediately or after a specified interval, to purchase up to 5,000 shares of stock (5,000 x 20 100,000). If the corporation wants to grant to the employee an ISO with respect to a greater quantity of shares, an ISO could be granted which is exercisable over a multi-year interval e. g. for a total of 10,000 shares, exercisable to the extent of 5,000 shares per year. If a corporation grants to an employee ISOs first becoming exercisable in a single year that relate to shares with a combined fair market value that exceeds 100,000, the rule precluding options on shares in excess of 100,000 per year from qualifying as ISOs is applied by taking options into account in the order in which they were granted. (10) An option will not be treated as an ISO if, at the time it is granted, the terms of the option provide that it will not be treated as an ISO. (11) Very often plans are adopted that authorize the grant of both ISOs and nonqualified options. Particularly (but not exclusively) in the context of granting options under such dual plans, the agreement or letter evidencing the grant of the option should state whether or not it is intended that the option be treated as an ISO. (12) III. Other Requirements The favorable tax treatment associated with ISOs will not be obtained, in general, unless the individual exercising the ISO is an employee of the corporation granting the option or of its parent or subsidiary corporation at all times during the period between the time the option is granted and the day which is three months before the option is exercised. (13) Thus, an employee terminating employment has three months from the date of termination to exercise an ISO option as such, unless the terms of the option specify that it lapses within a shorter period. If an employee becomes permanently and totally disabled, that individual may exercise an ISO as such at any time within one year after ceasing to be an employee. Also, the continued employment requirement described in the immediately preceding paragraph does not apply with respect to the exercise of an ISO by an employees estate or other distributee following the death of the employee. (14) The agreement or letter evidencing the grant of an ISO may set forth other restrictions on the exercise of the option, or on the disposition of shares acquired through the exercise of the option. Thus, options may be made exercisable only after a specified time interval, or after certain performance goals have been attained and the stock sold under an ISO may be subjected to restrictions on transfer, including a provision permitting or requiring the employer to buy the stock back under specified circumstances. IV. Consequences of Exercise of ISOs Generally, the holder of an ISO does not include any amount in income upon the receipt of shares pursuant to the exercise of the option, and the employer corporation is not allowed any deduction upon the transfer of the shares. The amount paid for the shares becomes the ISO holders basis in the shares so acquired. (15) Assuming that there has not been a disqualifying disposition of the shares (see below), and that the shares are held by the purchaser as a capital asset (which is generally the case), the sale or other disposition of the shares in a taxable transaction will result in a capital gain or loss to the holder. Under the Code as amended in 1997, if the shares are held for more than 18 months, the current maximum stated rate of federal income tax on gain from the disposition of the shares will be 20. For certain taxpayers having taxable income that would (without regard to the special rates applicable to capital gains) be taxed at a rate below 28, the maximum rate of tax on capital gains is currently 10. The employer or other corporation transferring stock pursuant to the exercise of an ISO must file an information return and must provide to the transferee, by January 31 of the calendar year following the transfer, a written statement with specified information relating to each transfer. (16) A disqualifying disposition occurs if shares acquired by an individual through the exercise of an ISO are sold or otherwise disposed of by the individual within two years after the grant of the option or within one year after the transfer of shares to the individual pursuant to the ISO. (17) In that event, under the rules governing the tax treatment of nonqualified options, the fair market value of the shares of stock on the date of exercise, as reduced by the amount paid for the shares, is included in the income of the employee as compensation and the employer takes the same amount into account as compensation expense. (18) The compensation income and expense is taken into account in the taxable years of the individual and the corporation in which the nonqualifying disposition occurred. (19) Alternative Minimum Tax The alternative minimum tax (or AMT) provisions of the Code impose an additional income tax equal to the excess, if any, of (i) the product of the taxpayers alternative minimum taxable income, or AMTI, as multiplied (after subtraction of an exemption amount) by specified rates (26-28 for noncorporate taxpayers), over (ii) the taxpayers regular tax for the year. (20) Alternative minimum taxable income is determined by reference to taxable income with specified adjustments. One of the adjustments applicable in computing an individuals AMTI is that the gain realized upon the transfer of shares of stock pursuant to the exercise of an ISO is taken into account under the regular rules applicable to nonqualified options, rather than under the ISO rules. Thus, the excess of the fair market value of the shares acquired on exercise over the amount paid for the shares is includible at the time of exercise in the individuals AMTI. If an individual is required to pay additional tax in the year of exercise by reason of the AMT, an offsetting tax credit may be available in a later year or years in which the individuals regular tax liability exceeds the individuals tentative tax under the minimum tax provisions. (21) This credit can be carried over indefinitely. The computations required under the credit provisions are complex, however, and the credit appears to expire if not used during the taxpayers lifetime. For these reasons as well as time-value-of-money considerations, many people attempt to spread the exercise of ISOs in such a manner as to avoid triggering an AMT liability. V. Facilitating the Exercise of ISOs In preparing an ISO plan, consideration should be given to possible means of facilitating the exercise of ISOs by employees. Two techniques for encouraging employees to exercise ISOs -- permitting employer stock to be transferred by the employee to the issuer of the option in payment of the exercise price, and lending funds to employees to finance the purchase of shares -- are discussed below. Note that some of the most popular measures for facilitating the exercise of options by employees with limited funds -- e. g. so-called cashless exercise programs, often involving the financing of the exercise price through a broker and an immediate sale of the shares so purchased to the extent necessary to pay the loan -- do not work well in the ISO context because of the ISO holding period requirements. The person exercising the ISO must hold the shares so acquired for a full year after purchase (and 2 full years after the option was granted) in order to avoid inclusion in income of the built-in gain (as of the time of exercise) as compensation and, to obtain the benefit of the most favorable capital gains rates now available, the shares must not be sold until more than 18 months after purchase. (Even lower capital gains rates are to apply to certain dispositions after the year 2000 of property held for more than five years.) Thus, from a tax perspective, the exercise of ISOs is most advantageous for employees willing and able to hold the shares so acquired for substantial periods of time. Also, the alternatives for payment of the option exercise price that are to be offered under an option plan should be considered before the option plan is adopted and, generally, should be set forth in the plan itself. If, for example, a plan provides that the option exercise price must be paid in cash in all instances, and it is later desired to permit the exercise price to be paid through the transfer of employer stock by the employee to the employer, an amendment to the plan may be necessary. Such an amendment may be treated as the grant of a new option to each holder of an ISO affected by the amendment. (22) Those options will then continue to qualify as ISOs only if they meet the pricing and other requirements of the ISO provisions at the time of the amendment. Thus, but for certain specific plan or option modifications which, by statute, are not considered to result in the grant of a new option, the amendment or other modification of existing options should generally be avoided. Therefore, every effort should be made to include in the option plan as originally adopted any special features that may ultimately be desired with respect to the exercise of options granted under the plan. Use of Stock of the Granting Corporation An ISO to purchase shares of stock of the employer corporation may permit an employee to pay the exercise price with other shares of stock of the same corporation. When an employee uses stock previously acquired to exercise an ISO, the shares transferred by the employee to the issuer of the option are deemed to have been exchanged for an equal number of shares from the ISO issuer, in an exchange with respect to which no income or gain is recognized if the holding periods applicable in the ISO context are met. (23) Thus, an ISO holder with previously acquired shares can use those shares to exercise the ISO without triggering the recognition of gain or incurring borrowing costs. If the exercise price is paid in the form of shares of employer stock, the employees basis in the shares of stock treated as having been acquired in exchange for the shares previously held is equal to the basis of the employee in the previously acquired shares. The employees holding period for the shares acquired in the exchange includes that which the employee had in the shares transferred to the employer. The employees basis in the additional shares of stock acquired by reason of the exercise of the ISO is zero, and the holding period for the additional shares begins at the time of the purchase pursuant to the option. The Service has ruled in at least one private letter ruling that an employees constructive, but not actual, surrender of stock of the employer corporation to exercise an ISO will be treated as an actual exchange for tax purposes -- avoiding the need for an actual tender of those shares. (24) The following example illustrates the consequences of the use of previously acquired stock of an employer to exercise an ISO. Assume that an individual employed by a corporation owns 1,000 shares of the stock of the employer, purchased on the open market, with a basis of 10 per share that the current fair market value of the stock is 40 per share and that the employee also has an ISO to purchase 400 shares of the employers stock for 20 per share. If the option permits the use of stock to pay the exercise price for the option, the employee may exercise the ISO and acquire 400 shares of employer stock, for aggregate consideration of 8,000, by tendering 200 shares. The employee will have a substituted basis of 10 per share in 200 shares of the newly acquired stock, and a basis of zero in the other 200 shares acquired. If stock acquired through the exercise of an ISO (option stock) is used to exercise an ISO, and the stock holding period requirements for ISO treatment (that is, no disposition within two years after the grant of the option or within one year after the transfer of shares to the optionee pursuant to the option) are not met, the use of the option stock to exercise the ISO will constitute a nonqualified disposition of those shares. Therefore, the employee will recognize ordinary income upon the disposition of the option stock used in the exercise, generally to the extent of the excess of the fair market value of the shares over the amount paid for the option stock. (25) Under proposed regulations, however, by reason of Code section 1036 no additional gain will be recognized if the value of the option stock at the time of disposition exceeds the amount taken into account as ordinary income because of the early disposition. (26) If an ISO is exercised with previously acquired shares, resulting in a basis allocation between shares deemed acquired in exchange under section 1036 and other shares as described above, and there is then a disqualifying disposition of some of the shares acquired pursuant to the ISO, the stock with the lowest basis is deemed to be disposed of. (27) Where employees are permitted to exercise ISOs with previously acquired stock, some employers have granted reload options to providing the employees with the right to purchase a quantity of shares equal to that surrendered to the corporation in connection with the ISO exercise. The reload option preserves an employees opportunity to benefit, to the same extent as before the exercise, from further appreciation in the stock of the employer. Loans From the Granting Corporation Another means of facilitating the exercise of options is to offer loans to employees of all or a portion of the funds needed to exercise the options. Such loans should, however, be approached with caution. Any such loan by an employer or affiliate should be properly documented with a promissory note, and be made on arms length terms and with adequate security (perhaps including a pledge of the shares purchased), so as to minimize the risk that the loan transaction may be recharacterized by the Internal Revenue Service as the payment of additional compensation or (in certain circumstances) as a dividend. Also, if the exercise price is lent on a nonrecourse basis secured only by the shares acquired, there may, depending on the circumstances, be some uncertainty as to whether the employee has in substance purchased the shares pursuant to the ISO, or merely entered into an option to acquire the shares upon payment of the purported debt. (28) As compared to nonqualified stock options, ISOs offer significant advantages for employees and merit serious consideration as an addition or alternative to nonqualified options and other types of equity compensation arrangements. If the requirements imposed by the Code relating to the grant and exercise of ISOs pursuant to the plan are met, an employee: will not be required to include any amount in the employees income upon the exercise of an ISO will defer the recognition of any gain with respect to the shares so acquired, for so long as the employee does not dispose of the shares and, upon any ultimate sale of the shares, will generally take any gain into account as capital gain. Employees can achieve an extra element of gain deferral by exercising an ISO with stock of the employer corporation. From the employers perspective, ISOs provide the same non-tax benefits as nonqualified options, by linking the employees personal financial interest to the value of the stock of the corporation and thereby providing employees with a direct incentive to contribute to corporate performance. Incentive stock options also, by reason of their particular tax characteristics, provide to employees a strong incentive to retain the shares acquired through the exercise of such options, thereby strengthening employees long-term interest in the continued prosperity of their employer. Taking into account the expanding differential between the tax rates applicable to compensation taxable as ordinary income and the rates applicable to capital gains, the advantages of ISOs will in many cases exceed any detriment to the corporation from the loss of deductions upon the exercise of stock options. Thus, ISOs are becoming more attractive as an element of employee compensation. 1. See, PG Plans to Offer Its Stock Options To Nearly All Workers . Wall Street Journal, Nov. 7, 1997, at B9, col. 3. 8. IRC Search7RH422(c)(5) Temporary Reg. Search7RH14a.422A-1, A-2(c)(6). 10. If a stock option plan authorizes both ISOs and nonqualified options, and the aggregate fair market value of the options to be issued to an employee for exercise beginning in the same year will exceed 100,000, some of the options may be designated as ISOs and others as nonqualified options. 11. IRC Search7RH422(b) (last sentence). 12. Temporary Reg. Search7RH14a.422A-1, A-20. 15. IRC Search7RHSearch7RH421(a)(1), 1012. 16. IRC Search7RH6039 Reg. Search7RHSearch7RH1.6039-1, 1.6039-2. 17. IRC Search7RHSearch7RH421(b), 422(a). 18. See Reg. Search7RHSearch7RH1.83-6(a)(1), 1.83-7(a). 22. See IRC Search7RH424(h). 23. See IRC Search7RH1036 Proposed Reg. Search7RH1.422A-2(i)(1) Rev. Rul. 80-244, 1980-2 C. B. 234. For a more extensive discussion of the consequences of the use of stock to exercise an ISO, see Norman J. Misher, Tax Consequences of Exercising An Incentive Stock Option with Stock of the Granting Corporation . 36 The Tax Executive 357 (July, 1984). 24. PLR 9736040 (June 10, 1997). 25. IRC Search7RH424(c)(3). If there is a disqualifying disposition (whether or not relating to the exercise of another ISO), and the disposition is a sale or exchange with respect to which a loss would, if sustained, be recognized to the individual, the amount of compensation includible in the employees income -- and the employers related deduction for compensation expense -- is limited to the excess of the amount realized over the adjusted basis for the shares. For example, if stock with a value of 25 per share is acquired pursuant to the exercise of an ISO for 10 per share, and the shares are sold to a third party six months later in a disqualifying disposition for an amount realized of 20 per share, the amount includible in the employees income as compensation, and potentially deductible by the employer, is limited to 10 per share. 26. See Proposed Reg. Search7RH1.422A-2(i)(4), Ex. 3. 27. Proposed Reg. Search7RH1.422A-2(i)(1)(ii). 28. See Reg. Search7RH1.83-3(a)(2).This document contains final regulations relating to statutory options. These final regulations affect certain taxpayers who participate in the transfer of stock pursuant to the exercise of incentive stock options and the exercise of options granted pursuant to an employee stock purchase plan (statutory options). These regulations provide guidance to assist these taxpayers in complying with the law in addition to clarifying rules regarding statutory options. Effective Date: These regulations are effective on August 3, 2004. For rules concerning reliance and transition period, see sectsect1.421-1(j)(2), 1.421-2(f)(2), 1.422-5(f)(2), and 1.424-1(g)(2). FOR FURTHER INFORMATION CONTACT: The collection of information contained in these final regulations (see sect1.6039-1) has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U. S.C. 3507) under control number 1545-0820. Responses to this collection of information are required to assist taxpayers with the completion of their income tax returns for the taxable year in which a disposition of statutory option stock occurs. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by the Office of Management and Budget. The estimated annual burden per respondent varies from 15 minutes to 25 minutes, depending on individual circumstances, with an estimated average of 20 minutes. Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U. S.C. 6103. Background This document contains amendments to 26 CFR part 1 under sections 421, 422, and 424 of the Internal Revenue Code (Code). Changes to the applicable tax law concerning section 421 were made by sections 11801 and 11821 of the Omnibus Budget Reconciliation Act of 1990 (OBRA 90), Public Law 101-508 (104 Stat. 1388). Changes to the applicable tax law concerning section 424 were made by section 1003 of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Public Law 100-647 (102 Stat. 3342), sections 11801 and 11821 of OMBRA 90, which included re-designating section 425 as section 424 of the Code, and section 1702(h) of the Small Business Job Protection Act of 1996, Public Law 104-88 (110 Stat. 1755). Changes concerning section 422 were made by section 251 of the Economic Recovery Tax Act of 1981, Public Law 97-34 (95 Stat. 172), which added section 422A to the Code. Related changes to section 422A were made by section 102(j) of the Technical Corrections Act of 1982, Public Law 97-448 (96 Stat. 2365), section 321(a) of Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 2085), section 1003(d) of TAMRA, and sections 11801 and 11821 of OBRA 90, which included re-designating section 422A as section 422 of the Code. Regulations under section 421 governing the requirements for restricted stock options and qualified stock options, as well as options granted under an employee stock purchase plan, were published in the Federal Register on December 9, 1957 (T. D. 6276, 1957-2 C. B. 271), November 26, 1960 (T. D. 6500), January 19, 1961 (T. D. 6527, 1961-1 C. B. 153), January 20, 1961 (T. D. 6540, 1961-1 C. B. 161), December 12, 1963 (T. D. 6696, 1963-2 C. B. 23), June 24, 1966 (T. D. 6887, 1966-2 C. B. 129), July 24, 1978 (T. D. 7554, 1981-1 C. B. 56), and November 3, 1980 (T. D. 7728, 1980-2 C. B. 236). Temporary regulations under section 422A providing guidance and transitional rules related to incentive stock options were published in the Federal Register on December 17, 1981 (T. D. 7799, 1982-1 C. B. 67) and September 18, 1992 (T. D. 8435, 1992-2 C. B. 324).Final regulations under section 422 related to stockholder approval were published in the Federal Register on December 1, 1988 (T. D. 8235, 1989-1 C. B. 117) and November 29, 1991 (T. D. 8374, 1991-2 C. B. 320). Regulations under section 425 were published in the Federal Register on June 23, 1966 (T. D. 6887, 1966-2 C. B. 129). Proposed changes to the final regulations under sections 421, 424, and 6039 and proposed regulations under section 422A were previously published in the Federal Register at 49 FR 4504 (LR-279-81, 1984-1 C. B. 714) on February 7, 1984 (the 1984 proposed regulations). With the exception of certain stockholder approval rules, the 1984 proposed regulations provided a comprehensive set of rules under section 422 of the Code. The 1984 proposed regulations and the temporary regulations have been withdrawn. See 68 FR 34344. On June 9, 2003, a notice of proposed rulemaking (REG-122917-02, 2003-27 I. R.B. 15) was published in the Federal Register at 68 FR 34344 (the 2003 proposed regulations). No hearing concerning the 2003 proposed regulations was held however, the IRS received written and electronic comments responding to this notice. After consideration of these comments, the 2003 proposed regulations are adopted as amended by this Treasury decision. The significant revisions are discussed below. Explanation of Provisions In general, the income tax treatment of the grant of an option to purchase stock in connection with the performance of services and of the transfer of stock pursuant to the exercise of such option is determined under section 83 of the Code and the regulations thereunder. However, section 421 of the Code provides special rules for determining the income tax treatment of the transfer of shares of stock pursuant to the exercise of an option if the requirements of section 422(a) or 423(a), as applicable, are met. Section 422 applies to incentive stock options, and section 423 applies to options granted under an employee stock purchase plan (collectively, statutory options). Under section 421, if a share of stock is transferred to an individual pursuant to the exercise of a statutory option, there is no income at the time of exercise of the option with respect to such transfer, and no deduction under section 162 is allowed to the employer corporation with respect to such transfer. However, pursuant to section 56(b)(3), section 421 does not apply with respect to the exercise of an incentive stock option for purposes of the individual alternative minimum tax. Section 422(a) of the Code provides that section 421 applies to the transfer of stock to an individual pursuant to the exercise of an incentive stock option if (i) no disposition of the share is made within 2 years from the date of grant of the option or within 1 year from the date of transfer of the share, and (ii) at all times during the period beginning on the date of grant and ending on the day 3 months before the exercise of the option, the individual is an employee of either the corporation granting the option or a parent or subsidiary of such corporation, or a corporation (or a parent or subsidiary of such corporation) issuing or assuming a stock option in a transaction to which section 424(a) applies. Section 422(b) provides several requirements that must be met for an option to qualify as an incentive stock option. Section 422(c) provides special rules applicable to incentive stock options, and section 422(d) provides a 100,000 per year limitation with respect to incentive stock options. Section 424 of the Code provides special rules applicable to statutory options, including rules concerning the modification of statutory options and the substitution or assumption of an option by reason of a corporate merger, consolidation, acquisition of property or stock, separation, reorganization, or liquidation. Section 424 also contains definitions of certain terms, including disposition . parent corporation . and subsidiary corporation . Finally, section 424 provides special rules related to attribution of stock ownership and the effect of stockholder approval on the date of grant of a statutory option. These final regulations provide comprehensive rules governing incentive stock options that, as did the 2003 proposed regulations, incorporate many of the rules contained in the 1984 proposed regulations. However, the 2003 proposed regulations are re-numbered, and these final regulations adopt that reorganization. These final regulations also make changes to the final regulations under sections 421 and 424 to provide additional guidance, as discussed below, in certain areas, to reflect the new organizational structure of the statutory option rules (including the re-designation of sect1.425-1 as sect1.424-1), and to remove obsolete rules and cross-references. Section 421: General Rules Sections 422 and 423 provide that a statutory option may be granted to an individual who is an employee of the corporation granting the option, a parent or subsidiary of such corporation, or a corporation or a parent or subsidiary of such corporation issuing or assuming a stock option in a transaction to which section 424(a) applies. Section 1.421-1(h) of the 2003 proposed regulations further describes the requisite employment relationship for purposes of a statutory option. The 2003 proposed regulations provide that an option is a statutory option only if, at the time the option is granted, the optionee is an employee of the corporation granting the option or a related corporation of such corporation. In the case of an assumption or substitution under sect1.424-1(a), the optionee must, at the time of the assumption or substitution, be an employee of the corporation assuming or substituting the option or a related corporation of such corporation. In response to comments, these final regulations provide that in the case of an assumption or substitution under sect1.424-1(a) an option also will be treated as granted to an employee of the granting corporation if the optionee is an individual who is in the 3-month period following termination of the employment relationship. Section sect1.421-1(h)(2) of the 2003 proposed regulations also provides that the employment relationship is considered to continue intact while an individual is on military leave, sick leave, or other bona fide leave of absence if the period of leave does not exceed 3 months, or if longer, so long as the individual8217s right to reemployment with the corporation granting the option (or a related corporation of such corporation) or a corporation assuming or substituting an option under sect1.424-1(a) is guaranteed by statute or contract. Commentors requested clarification in the final regulations concerning whether the right to reemployment must be absolute and whether the right to reemployment provided by the Family Medical Leave Act or the Uniformed Services Employment and Reemployment Rights Act satisfies the requirements of this section. These final regulations provide that the right to reemployment must be provided by statute or contract. Thus, for example, if an optionee is on leave pursuant to the Family Medical Leave Act, the Uniformed Services Employment and Reemployment Rights Act, or any similar statute providing for continued employment rights for an extended period of time, the employment relationship is considered intact. Section 422: Incentive Stock Options 1. Special rules regarding disqualifying dispositions The general rules concerning disqualifying dispositions are described in sect1.421-2(b) of the 2003 proposed regulations. Under these rules, if there is a disqualifying disposition of a share of stock, the special tax treatment provided by section 421 and sect1.421-2(a) does not apply to the transfer of the share. The effects of a disqualifying disposition are determined under section 83(a). Thus, in the taxable year in which the disqualifying disposition occurs, the individual must recognize compensation income equal to the fair market value of the stock (determined without regard to any lapse restriction and without regard to any reduction for any brokerage fees or other costs paid in connection with the disposition) on the date the stock is substantially vested less the exercise price. (See section 422(c)(2) concerning special rules that are applicable where the amount realized in a disposition is less than this difference.) A deduction is allowable for the taxable year in which such disqualifying disposition occurs to the employer corporation, its parent or subsidiary corporation, or a corporation substituting or assuming an option in a transaction to which sect1.424-1(a) applies. Section 422(c)(2) and sect1.422-1(b) of the 2003 proposed regulations provide special rules concerning disqualifying dispositions. The application of the disqualifying disposition rules is described in several examples in sect1.422-1(b)(3) of the 2003 proposed regulations. In Example 1 of sect1.422-1(b)(3) of the 2003 proposed regulations, on exercise of an incentive stock option, the optionee receives vested stock and disposes of the stock before meeting the applicable holding period. In this example, the amount of compensation income is based on the fair market value of the stock on the date of exercise less the exercise price, and the section 422(a)(1) holding period is based on the date of exercise. However, in Example 2 of sect1.422-1(b)(3) of the 2003 proposed regulations, the optionee receives nonvested stock on exercise of an incentive stock option. This example retains the same holding period for the receipt of nonvested stock, but computes the amount of compensation income based on the date of vesting of the underlying stock (rather than the date of exercise). Several commentors suggested that if the option is exercised for nonvested stock the compensation income should not be calculated on the date of vesting because section 83 does not apply to a transaction to which section 421 applies (and section 421(b) applies to a disqualifying disposition). Instead, the compensation income should be computed on the date of exercise. Alternatively, if the proposed rule is retained, commentors suggest that the final regulations and examples provide that an optionee may make a protective section 83(b) election on exercise of the option. These final regulations retain the rules described in the 2003 proposed regulations, however, the examples in sect1.422-1(b)(3) of the final regulations more fully describe the application of the disqualifying disposition rules. Specifically, Example 2 indicates that pursuant to section 83(e)(1) of the Code, section 83 does not apply to a transaction to which section 421 applies. Thus, on exercise of a statutory option section 83 does not apply, and an optionee cannot make an effective election under section 83(b) for purposes of the income tax consequences on the date of exercise. However, an effective election under section 83(b) may be made for purposes of the alternative minimum tax, which calculates income as if section 83 applies. Example 2 also illustrates that on a disqualifying disposition, the rules of section 83 and the regulations thereunder (rather than section 422 and the regulations thereunder) are used to determine the amount of compensation includible in income. Applying the rules under section 83(a), the amount of compensation includible is the difference between the fair market value of the stock on the date the substantial risk of forfeiture lapses less the fair market value on the date of exercise. Additionally, Example 2 demonstrates that there is a transfer (as defined in sect1.421-1(g) of the final regulations) of the stock on the date of exercise for purposes of the holding period requirement of section 422(a)(1). Thus, the holding period for the transfer of the stock for purposes of section 422 and the holding period requirements begins on the date of exercise (rather than the date of vesting).See also, sect1.422-1(b)(3), Example 3 . However, in the event of a disqualifying disposition, the amount of capital gain (if any) and the holding period for purposes of determining capital gain is computed from the date of vesting. 2. Shareholder approval Among other requirements, to qualify as an incentive stock option, the option must be granted pursuant to a plan which is approved by the stockholders of the granting corporation within 12 months before or after the date the plan is adopted. See section 422(b) and sect1.422-2(b)(2)(i) of the 2003 proposed regulations. These final regulations retain the rules contained in the 2003 proposed regulations concerning shareholder approval. However, an additional example in sect1.422-2(b)(6) illustrates the shareholder approval requirements where an incentive stock option plan is assumed in connection with a corporate transaction. See sect1.422-2(b)(6), Example 3 . In Example 3 of sect1.422-2(b)(6) of these final regulations, Corporation X maintains an incentive stock option plan, but Corporation Y does not maintain such a plan. The companies combine to form one corporation that will be named Y, the plan will be continued by Y, and future grants under the plan will be made by Y (the new combined entity). The consolidation agreement describes the plan, including the maximum aggregate number of shares available for issuance pursuant to incentive stock options under the plan after the consolidation and the employees eligible to receive options under the plan. Because there is a change in the granting corporation under sect1.422-2(b)(3)(iii), Y is considered to have adopted a new plan that must satisfy the shareholder approval requirements. In this example, because the consolidation agreement describes the plan and indicates that it will continue after the consolidation, the shareholder approval requirements of sect1.422-2(b)(3) are satisfied, and the plan is considered adopted and approved on the date the consolidation agreement is approved. See Rev. Rul. 68-233, 1968-1 C. B. 187. 3. Maximum aggregate number of shares Section 422(b)(1) provides that an incentive stock option must be granted pursuant to a plan that includes the aggregate number of shares which may be issued under options. Section 1.422-2(b)(3)(i) of the 2003 proposed regulations provides that the plan must designate the maximum aggregate number of shares that may be issued under the plan through incentive stock options, nonstatutory options, and all other stock-based awards to be granted under the plan. In response to comments, these final regulations provide that the plan must designate the maximum aggregate number of shares that may be issued under the plan through incentive stock options. Thus, for example, if a corporation maintains an omnibus plan under which incentive stock options, nonstatutory options, and other stock-based awards may be made, the plan must contain a maximum number of shares that may be issued as incentive stock options under the plan. Such a number may be expressed as a limit specific to incentive stock options or as a limit on all awards under the plan, including incentive stock options. These final regulations do not require the plan to include the maximum number of shares that may be issued pursuant to nonstatutory options or other stock-based awards. Commentators also asked whether the maximum aggregate number of shares that may be issued under an incentive stock option plan is affected by the use of outstanding shares used to exercise an option. Under these final regulations, only the net number of shares that are issued pursuant to the exercise of a statutory option are counted against the maximum aggregate number of shares. For example, if the exercise price of an option to purchase 100 shares equals the value of 20 shares, and the corporation permits the employee to use those 20 of the 100 shares to pay the exercise price of the option, and the corporation only issues 80 shares to the optionee, then 80 shares are counted against the maximum aggregate number of shares (rather than 100). 4. Option price Under section 422(b)(4), the option price of an incentive stock option must not be less than the fair market value of the stock at the time the option is granted. The 2003 proposed regulations retain this rule, but also provide that the option price may be determined in any reasonable manner, including the valuation methods permitted under sect20.2031-2 (Estate Tax Regulations), so long as the minimum price possible under the terms of the option is not less than the fair market value of the stock on the date of grant. Section 1.422-2(e)(2)(i) of the 2003 proposed regulations provides that if a share of stock is transferred to an individual pursuant to the exercise of an incentive stock option, which fails to qualify as an incentive stock option because the exercise price is less than the fair market value of the underlying stock on the date of grant, such requirement is still considered to have been met if there was an attempt, made in good faith, to meet the option price requirements of sect1.422-2(e)(1). For nonpublicly traded stock, sect1.422-2(e)(2)(iii) provides that if it is demonstrated that the fair market value of the stock on the date of grant was based on an average of the fair market values as of such date set forth in the opinions of completely independent and well-qualified experts, such a determination establishes that a good-faith attempt to meet the option price requirements of sect1.422-2(e) was made. Taxpayers are required to retain adequate books and records to demonstrate that the option price requirements are satisfied. See section 6001. Commentors suggested that the final regulations be revised to provide that a good-faith attempt to meet the option price requirements is demonstrated if the value of the stock is determined by a qualified appraiser (as defined in sect1.170A-13(c)(5)), by an individual (rather than more than one individual) who is not a qualified appraiser, or by the corporation at the date of grant. Because of concerns that the value determined under these approaches may not reliably reflect the fair market value of the stock on the date of grant, these final regulations retain the rules described in the 2003 proposed regulations. 5. 100,000 limitation Section 422(d)(1) provides that, to the extent that the aggregate fair market value of stock with respect to which incentive stock options (determined without regard to section 422(d)) are exercisable for the first time by an individual during the calendar year (under all of the plans of the employer corporation and any related corporation) exceeds 100,000, such options are not treated as incentive stock options. Under section 422(d)(2), options are taken into account in the order in which they are granted. Section 422(d)(3) provides that the fair market value of stock is determined at the time the option is granted. Section 1.422-4(b)(5)(ii) of the 2003 proposed regulations provides that if the option is not canceled, modified, or transferred prior to the year in which it would first become exercisable, it is treated as outstanding until the end of the year in which it first becomes exercisable. Commentors suggested that the final regulations permit an individual to cancel, modify, or transfer an option at any time prior to the date of exercise (rather than the year it first becomes exercisable). Because of concerns about the administrability of a rule that, for purposes of the 100,000 limitation, would permit an individual to determine the status of an option as statutory or nonstatutory until the date of exercise, these final regulations retain the rule described in the 2003 proposed regulations. Section 1.422-4(c) of the 2003 proposed regulations provides that the application of the 100,000 limitation may result in an option being treated, in part, as an incentive stock option and, in part, as a nonstatutory option. In response to comments, these final regulations provide additional guidance concerning the treatment of options (and the stock purchasable thereunder) that are bifurcated into an incentive stock option and nonstatutory option as a result of the application of the 100,000 limitation. These final regulations provide that a corporation may issue a separate certificate for incentive stock option stock or designate such stock as incentive stock option stock in the corporation8217s transfer records or the plan records. The issuance of separate certificates or designation in plan records is not considered a modification under sect1.424-1(e). However, in the absence of such an issuance or designation, shares are deemed purchased under an incentive stock option first to the extent of the 100,000 limitation, and then the excess shares are deemed purchased under a nonstatutory option. Section 424: Definitions and Special Rules 1. Substitution, Assumption, and Modification of Options Section 424(h)(1) provides that if the terms of an option are modified, extended, or renewed, such modification, renewal, or extension is treated as the grant of a new option. Under section 424(h)(3), the term modification (with certain exceptions) means any change in the terms of an option which gives the optionee additional benefits under the option. One exception to this definition is that a change in the terms of an option attributable to a substitution or an assumption that meets the requirements of section 424(a) is not a modification of an option. The 2003 proposed regulations provide that an eligible corporation (as defined in sect1.424-1(a)(2)) may, by reason of a corporate transaction (as defined in sect1.424-1(a)(3)), substitute a new statutory option (new option) for an outstanding statutory option (old option) or assume an old option without the substitution or assumption being considered a modification of the old option under section 424(h). These final regulations retain most of the rules contained in the 2003 proposed regulations, with certain changes. Under the 2003 proposed regulations, a corporate transaction is (i) a corporate merger, consolidation, acquisition of property or stock, separation, reorganization, or liquidation (ii) a distribution (excluding ordinary dividends), or change in the terms or number of outstanding shares of such corporation, such as a stock split or stock dividend (a change in capital structure) (iii) a change in the name of a corporation whose stock is purchasable under the old option and (iv) such other corporate events as may be prescribed by the Commissioner in published guidance. In response to comments, these final regulations provide that a 8220distribution8221 does not include a stock dividend or stock split (including a reverse stock split) that merely changes the number of outstanding shares of a corporation. Thus, an outstanding option is not treated as substituted or assumed under section 424(a) and sect1.424-1(a) in connection with a stock dividend or stock split that merely changes the number of outstanding shares. Instead, the exercise price of an outstanding option may be proportionally adjusted to reflect a stock dividend or stock split that merely changes the number of outstanding shares of a corporation under sect1.424-1(e). This adjustment is not a modification of the option, and because the stock dividend or stock split is not a corporate transaction, the requirements of sect1.424-1(a), including the spread and ratio tests, do not have to be satisfied. The 2003 proposed regulations also provide that a new or assumed option must otherwise qualify as a statutory option. See sect1.424-1(a)(5)(vi) of the 2003 proposed regulations. The 2003 proposed regulations provide that, except as necessary to comply with the specific requirements regarding substitution or assumption, such as the rules concerning ratio and spread, the option must comply with the requirements of sect1.422-2 of the 2003 proposed regulations or 1.423-2, as applicable. Thus, under the 2003 proposed regulations, for example, the new option must be substituted, or the old option must be assumed, under a plan approved by the stockholders of the corporation substituting or assuming the option. In Rev. Rul. 71-474, 1971-2 C. B. 215, involving qualified stock options, the IRS held that qualified stock options assumed by a corporation in a merger with the granting corporation retained their status as qualified stock options without approval of the assuming corporation8217s stockholders. In the ruling, the IRS indicated that approval of the persons who owned stock of the granting corporation at the time the plan originally was approved was sufficient to satisfy the stockholder approval requirements. In response to comments, these final regulations refrain from imposing an additional stockholder approval requirement for statutory options that have been granted and are outstanding at the time of a corporate transaction. Thus, the requirement in sect1.424-1(a)(5)(vi) of the 2003 proposed regulations is removed. Further, the examples in sect1.424-1(a)(10) of these final regulations demonstrate that if the shareholder approval requirements are met on the date of grant, a subsequent substitution or assumption of an outstanding option (old option) by an acquiring corporation does not require additional stockholder approval for the substituted or assumed option (new option) to continue to qualify as a statutory option. See, sect1.424-1(a)(10), Example 9 . For example, assume Corporation X maintains an incentive stock option plan that meets the requirements of sect1.422-2 on the date of grant. E, an employee of X, holds outstanding incentive stock options to acquire X stock on exercise of the options. If Corporation Y acquires X and substitutes new options to acquire Y stock for the old options to acquire X stock held by E, the substitution of the new Y options does not require new stockholder approval. The result is the same if the options are assumed by Y. However, for future options granted under the plan to qualify as incentive stock options, the plan must be approved by the Y shareholders. (See, sect1.422-2(b)(6) Example 3 . for guidance concerning future grants under an option plan that is assumed in a corporate transaction.) Finally, commentors requested guidance concerning the treatment of earn-out payments received by option holders in connection with a corporate transaction. Because of the factual nature of these transactions, these final regulations do not address the issues raised by these transactions. However, this area is currently under study and may be the subject of future guidance of general applicability under sect 601.601(d)(2). 2. Modification, extension, or renewal of option Section 424(h)(3) provides that a modification is any change in the terms of an option which gives the optionee additional benefits under the option, with certain specified exceptions. Under sect1.424-1(e)(4)(iii) of the 2003 proposed regulations, a change to an option providing that the optionee may receive an additional benefit under the option at the future discretion of the granting corporation is a modification of the option at the time the option is changed to provide the discretion. Additionally, the exercise of such discretion is a modification of the option. Although several commentors suggested that the final regulations provide that the later exercise of the discretion is not a modification of the option, these final regulations retain the rule contained in the 2003 proposed regulations. However, as under the 2003 proposed regulations, it is not a modification for the granting corporation to exercise discretion specifically reserved under an option related to the payment of a bonus at the time of the exercise of the option, the availability of a loan at exercise, or the right to tender previously-owned stock for the stock purchasable under the option. A change to an option adding such discretion, however, is a modification. Commentors suggested broadening this rule to include the exercise of any reserved discretion under the option. These final regulations, however, only expand this rule to provide that it is not a modification to exercise discretion specifically reserved under an option with respect to the payment of employment taxes andor withholding taxes resulting from the exercise of a statutory option. The 2003 proposed regulations also provide that an option is not modified merely because an optionee is offered a change in the terms of the option if the change is not made. These final regulations retain this rule, but also provide that if an offer to change the terms of the option remains outstanding for less than 30 days, the option is not modified. However, if the offer to change the terms of the option remains outstanding for 30 days or more, the option is treated as modified as of the date the offer to change the terms of the option is made. Finally, commentors suggested that these final regulations provide an exception to the modification rule for an inadvertent change to a statutory option where the change is promptly reversed. In response, these final regulations provide that any inadvertent modification of an option is not treated as a modification to the extent the modification is reversed by the earlier of the date the option is exercised or the last day of the calendar year during which such change occurred. Section 6039 Under section 1.6039-1(f) of the 2003 proposed regulations, the issue of furnishing electronic statements was reserved. These final regulations provide that the furnishing of statements in electronic form is permitted, provided the recipient consents to that means of delivery. Par. 2. Sections 1.421-1 through 1.421-6 are removed. Par. 3. Section 1.421-7 is re-designated as sect1.421-1 and is amended as follows: 1. In paragraph (a)(1), first sentence, the language 8220sections 421 through 4258221 is removed and 8220this sectsect1.421-1 through 1.424-18221 is added in its place. 2. In paragraph (a)(1), first sentence, the language 8220includes8221 is removed, and 8220means8221 is added in its place. 3. In paragraph (a)(1), removing the second sentence. 4. Removing the last sentence of paragraph (a)(1) and adding two sentences in its place. 5. Revising paragraph (a)(3). 6. Revising paragraphs (b)(1) and (b)(2). 7. In paragraph (b)(3)(i), third sentence, removing the language 82201.425-18221 and inserting 82201.424-18221 in its place. 8. In the list below, for each section indicated in the left column, remove the language in the middle column and add the language in the right column: Newly Designated Section 9. Revising the last sentence of paragraph (b)(3)(ii) Example 1 . 10. Removing the last sentence of paragraph (b)(3)(ii) Example 2 . and adding two sentences in its place. 11. Removing the first sentence of paragraph (c)(1) and adding two new sentences in its place. 12. In paragraph (c)(2), second sentence, the language 82204258221 is removed and 82204248221 is added in its place. 13. In paragraph (c)(3), second and last sentences, the language 822019648221 is removed and 822020048221 is added in its place. 14. In paragraph (c)(3), second sentence, the language 822019658221 is removed wherever it appears and 822020058221 is added in its place. 15. Revising paragraphs (d) and (e). 16. In paragraph (f), in the first sentence, the language 8220sections 421 through 4258221 is removed and 8220this section and sectsect1.421-2 through 1.424-18221 is added in its place. 17. Revising the last sentence of paragraph (f). 18. In paragraph (g), first sentence, the language 8220sections 421 through 4258221 is removed and 8220this section and sectsect1.421-2 through 1.424-18221 is added in its place. 19. Adding a new third, fourth, and fifth sentences to paragraph (g). 20. Revising the first, second, and third sentences of paragraph (h)(1). 21. Revising paragraph (h)(2). 22. In paragraph (h)(3), first sentence, the language 82204258221 is removed and 82204248221 is added in its place. 23. In paragraph (h)(3), last sentence, the language 8220or assuming8221 is removed and 8220the option or substituting or assuming the option8221 is added in its place. 24. In the list below, for each section indicated in the left column, remove the language in the middle column and add the language in the right column: Newly Designated Section 1.421-1(h)(4) Example 2 . last sentence for A is then employed by a corporation which issued an option under section 425(a). to the transfer of the M stock because, at all times during the period beginning with the date of grant of the X option and ending with the date of exercise of the M option, A was an employee of the corporation granting the option or substituting or assuming the option under sect1.424-1(a). 1.421-1(h)(4) Example 3 . second sentence 1.421-1(h)(4) Example 3 . third, fourth, and fifth sentences 1.421-1(h)(4) Example 4, first sentence 1.421-1(h)(4) Example 5 . first sentence 1.421-1(h)(4) Example 6 . first sentence an employment contract with M which provides that upon the termination of any military duty E may be required to serve, E will be entitled to reemployment with M or a parent or subsidiary of M. a right to reemployment with M or a related corporation on the termination of any military duty E may be required to serve. 1.421-1(h)(4) Example 6 . third sentence of M or a related corporation 1.421-1(h)(4) Example 6 . last sentence 1.421-1(h)(4) Example 7 . first and last sentences a qualified stock 1.421-1(h)(4) Example 7 . first sentence parent or subsidiary 1.421-1(h)(4) Example 7 . last sentence its parent and subsidiary corporation 1.421-1(h)(4) Example 7 . last sentence 25. Revising paragraph (i). 26. Adding paragraph (j). The additions and revisions read as follows: sect1.421-1 Meaning and use of certain terms. (a) (1) While no particular form of words is necessary, the option must express, among other things, an offer to sell at the option price, the maximum number of shares purchasable under the option, and the period of time during which the offer remains open. The term option includes a warrant that meets the requirements of this paragraph (a)(1). (3) An option must be in writing (in paper or electronic form), provided that such writing is adequate to establish an option right or privilege that is enforceable under applicable law. (b) Statutory options . (1) The term statutory option . for purposes of this section and sectsect1.421-2 through 1.424-1, means an incentive stock option . as defined in sect1.422-2(a), or an option granted under an employee stock purchase plan . as defined in sect1.423-2. (2) An option qualifies as a statutory option only if the option is not transferable (other than by will or by the laws of descent and distribution) by the individual to whom the option was granted, and is exercisable, during the lifetime of such individual, only by such individual. See sectsect1.422-2(a)(2)(v) and 1.423-2(j). Accordingly, an option which is transferable or transferred by the individual to whom the option is granted during such individual8217s lifetime, or is exercisable during such individual8217s lifetime by another person, is not a statutory option. However, if the option or the plan under which the option was granted contains a provision permitting the individual to designate the person who may exercise the option after such individual8217s death, neither such provision, nor a designation pursuant to such provision, disqualifies the option as a statutory option. A pledge of the stock purchasable under an option as security for a loan that is used to pay the option price does not cause the option to violate the nontransferability requirements of this paragraph (b). Also, the transfer of an option to a trust does not disqualify the option as a statutory option if, under section 671 and applicable State law, the individual is considered the sole beneficial owner of the option while it is held in the trust. If an option is transferred incident to divorce (within the meaning of section 1041) or pursuant to a domestic relations order, the option does not qualify as a statutory option as of the day of such transfer. For the treatment of nonstatutory options, see sect1.83-7. Example 1 . Because X was a subsidiary of P on the date of the grant of the statutory option, the option does not fail to be a statutory option even though X ceases to be a subsidiary of P. Example 2 . Because X was not a subsidiary of S or P on the date of the grant of the option, the option is not a statutory option even though X later becomes a subsidiary of P. See sectsect1.422-2(a)(2) and 1.423-2(b). (c) Time and date of granting option . (1) For purposes of this section and sectsect1.421-2 through 1.424-1, the language 8220the date of the granting of the option8221 and 8220the time such option is granted,8221 and similar phrases refer to the date or time when the granting corporation completes the corporate action constituting an offer of stock for sale to an individual under the terms and conditions of a statutory option. A corporate action constituting an offer of stock for sale 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. (d) Stock and voting stock . (1) For purposes of this section and sectsect1.421-2 through 1.424-1, the term stock means capital stock of any class, including voting or nonvoting common or preferred stock. Except as otherwise provided, the term includes both treasury stock and stock of original issue. Special classes of stock authorized to be issued to and held by employees are within the scope of the term stock as used in such sections, provided such stock otherwise possesses the rights and characteristics of capital stock. (2) For purposes of determining what constitutes voting stock in ascertaining whether a plan has been approved by stockholders under sect1.422-2(b) or 1.423-2(c) or whether the limitations pertaining to voting power contained in sectsect1.422-2(f) and 1.423-2(d) have been met, stock which does not have voting rights until the happening of an event, such as the default in the payment of dividends on preferred stock, is not voting stock until the happening of the specified event. Generally, stock which does not possess a general voting power, and may vote only on particular questions, is not voting stock. However, if such stock is entitled to vote on whether a stock option plan may be adopted, it is voting stock. (3) In general, for purposes of this section and sectsect1.421-2 through 1.424-1, ownership interests other than capital stock are considered stock. (e) Option price . (1) For purposes of this section and sectsect1.421-2 through 1.424-1, the term option price . price paid under the option . or exercise price means the consideration in cash or property which, pursuant to the terms of the option, is the price at which the stock subject to the option is purchased. The term option price does not include any amounts paid as interest under a deferred payment arrangement or treated as interest. (2) Any reasonable valuation method may be used to determine whether, at the time the option is granted, the option price satisfies the pricing requirements of sections 422(b)(4), 422(c)(5), 422(c)(7), and 423(b)(6) with respect to the stock subject to the option. Such methods include, for example, the valuation method described in sect20.2031-2 of this chapter (Estate Tax Regulations). (f) Exercise . An agreement or undertaking by the employee to make payments under a stock purchase plan does not constitute the exercise of an option to the extent the payments made remain subject to withdrawal by or refund to the employee. (g) Transfer . For purposes of section 422, a transfer may occur even if a share of stock is subject to a substantial risk of forfeiture or is not otherwise transferable immediately after the date of exercise. See sect1.422-1(b)(3) Example 2 . A transfer does not fail to occur merely because, under the terms of the arrangement, the individual may not dispose of the share for a specified period of time, or the share is subject to a right of first refusal or a right to reacquire the share at the share8217s fair market value at the time of sale. (h) Employment relationship . (1) An option is a statutory option only if, at the time the option is granted, the optionee is an employee of the corporation granting the option, or a related corporation of such corporation. If the option has been assumed or a new option has been substituted in its place under sect1.424-1(a), the optionee must, at the time of such substitution or assumption, be an employee (or a former employee within the 3-month period following termination of the employment relationship) of the corporation so substituting or assuming the option, or a related corporation of such corporation. The determination of whether the optionee is an employee at the time the option is granted (or at the time of the substitution or assumption under sect1.424-1(a)) is made in accordance with section 3401(c) and the regulations thereunder. (2) In addition, sect1.421-2(a) is applicable to the transfer of a share pursuant to the exercise of the statutory option only if the optionee is, at all times during the period beginning with the date of the granting of such option and ending on the day 3 months before the date of such exercise, an employee of either the corporation granting such option, a related corporation of such corporation, or a corporation (or a related corporation of such corporation) substituting or assuming a stock option in a transaction to which sect1.424-1(a) applies. For purposes of the preceding sentence, the employment relationship is treated as continuing intact while the individual is on military leave, sick leave, or other bona fide leave of absence (such as temporary employment by the Government) if the period of such leave does not exceed 3 months, or if longer, so long as the individual8217s right to reemployment with the corporation granting the option (or a related corporation of such corporation) or a corporation (or a related corporation of such corporation) substituting or assuming a stock option in a transaction to which sect1.424-1(a) applies, is provided either by statute or by contract. If the period of leave exceeds 3 months and the individual8217s right to reemployment is not provided either by statute or by contract, the employment relationship is deemed to terminate on the first day immediately following such three-month period. Thus, if the option is not exercised before such deemed termination of employment, sect1.421-2(a) applies to the transfer of a share pursuant to an exercise of the option only if the exercise occurs within 3 months from the date the employment relationship is deemed terminated. (i) Additional definitions . (1) Corporation . For purposes of this section and sectsect1.421-2 through 1.424-1, the term corporation has the meaning prescribed by section 7701(a)(3) and sect301.7701-2(b) of this chapter. For example, a corporation for purposes of the preceding sentence includes an S corporation (as defined in section 1361), a foreign corporation (as defined in section 7701(a)(5)), and a limited liability company that is treated as a corporation for all Federal tax purposes. (2) Parent corporation and subsidiary corporation . For the definition of the terms parent corporation (and parent ) and subsidiary corporation (and subsidiary ), for purposes of this section and sectsect1.421-2 through 1.424-1, see sect1.424-1(f)(i) and (ii), respectively. Related corporation as used in this section and in sectsect1.421-2 through 1.424-1 means either a parent corporation or subsidiary corporation. (j) Effective date 8212 (1) In general . These regulations are effective on August 3, 2004. (2) Reliance and transition period . For statutory options granted on or before June 9, 2003, taxpayers may rely on the 1984 proposed regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-122917-02 (68 FR 34344), or this section until the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring 6 months after August 3, 2004. For statutory options granted after June 9, 2003, and before the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after August 3, 2004, taxpayers may rely on either the REG-122917-02 or this section. Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 2005. Reliance on LR-279-81, REG-122917-02, or this section must be in its entirety, and all statutory options granted during the reliance period must be treated consistently. Par. 4. Section 1.421-8 is re-designated as 1.421-2 and is amended by: 1. Revising paragraphs (a)(1), (b), and (c)(1). 2. In paragraph (c)(2), first sentence, add the phrase 8220for purposes of section 423(c)8221 at the end of the first sentence. 3. In the list below, for each section indicated in the left column, remove the language in the middle column and add the language in the right column: (a) Effect of qualifying transfer . (1) If a share of stock is transferred to an individual pursuant to the individual8217s exercise of a statutory option, and if the requirements of sect1.422-1(a) (relating to incentive stock options) or sect1.423-1(a) (relating to employee stock purchase plans) whichever is applicable, are met, then8212 (i) No income results under section 83 at the time of the transfer of such share to the individual upon the exercise of the option with respect to such share (ii) No deduction under sections 83(h) or 162 or the regulations thereunder (relating to trade or business expenses) is allowable at any time with respect to the share so transferred and (iii) No amount other than the price paid under the option is considered as received by the employer corporation, a related corporation of such corporation, or a corporation substituting or assuming a stock option in a transaction to which sect1.424-1(a) (relating to corporate reorganizations, liquidations, etc.) applies, for the share so transferr ed. (b) Effect of disqualifying disposition . (1)(i) The disposition (as defined in sect1.424-1(c)) of a share of stock acquired by the exercise of a statutory option before the expiration of the applicable holding periods as determined under sect1.422-1(a) or 1.423-1(a) is a disqualifying disposition and makes paragraph (a) of this section inapplicable to the transfer of such share. See section 83(a) to determine the amount includible on a disqualifying disposition. The income attributable to such transfer (determined without reduction for any brokerage fees or other costs paid in connection with the disposition) is treated by the individual as compensation income received in the taxable year in which such disqualifying disposition occurs. A deduction attributable to such transfer is allowable, to the extent otherwise allowable under section 162, for the taxable year in which such disqualifying disposition occurs to the employer corporation, or a related corporation of such corporation, or a corporation substituting or assuming an option in a transaction to which sect1.424-1(a) applies. Additionally, the amount allowed as a deduction must be determined as if the requirements of section 83(h) and sect1.83-6(a) apply. No amount is treated as income, and no amount is allowed as a deduction, for any taxable year other than the taxable year in which the disqualifying disposition occurs. If the amount realized on the disposition exceeds (or is less than) the sum of the amount paid for the share and the amount of compensation income recognized as a result of such disposition, the extent to which the difference is treated as gain (or loss) is determined under the rules of section 302 or 1001, as applicable. (ii) The following examples illustrate the principles of this paragraph (b): Example 1 . On June 1, 2006, X Corporation grants an incentive stock option to A, an employee of X, entitling A to purchase 100 shares of X stock at 10 per share. On August 1, 2006, A exercises the option when the fair market value of X stock is 20 per share, and 100 shares of X stock are transferred to A on that date. On December 15, 2007, A sells the stock for 20 per share. Because A disposed of the stock before June 2, 2008, A did not satisfy the holding period requirements of sect1.422-1(a). Under paragraph (b)(1)(i) of this section, A therefore made a disqualifying disposition of the stock. Thus, paragraph (a) of this section is inapplicable to the transfer of the shares, and A must include the compensation income attributable to the transfer of the shares in gross income in the year of the disqualifying disposition. The amount of compensation income A must include in income is 1,000 (2,000, the fair market value of X stock on transfer less 1,000, the exercise price per share). If the requirements of sect83(h) and sect1.83-6(a) are satisfied and otherwise allowable under section 162, X is allowed a deduction of 1,000 for its taxable year in which the disqualifying disposition occurs. Przykład 2. Y Corporation grants an incentive stock option for 100 shares of its stock to E, an employee of Y. The option has an exercise price of 10 per share. E exercises the option and is transferred the shares when the fair market value of a share of Y stock is 30. Before the applicable holding periods are met, Y redeems the shares for 70 per share. Because the holding period requirements of sect1.422-1(a) are not met, the redemption of the shares is a disqualifying disposition of the shares. Under paragraph (b)(1)(i) of this section, A made a disqualifying disposition of the stock. Thus, paragraph (a) of this section is inapplicable to the transfer of the shares, and E must include the compensation income attributable to the transfer of the shares in gross income in the year of the disqualifying disposition. The amount of compensation income that E must include in income is 2,000 (3,000, the fair market value of Y stock on transfer, less 1,000, the exercise price paid by E). The character of the additional gain that is includible in E8217s income as a result of the redemption is determined under the rules of section 302. If the requirements of sect83(h) and sect1.83-6(a) are satisfied and otherwise allowable under section 162, Y is allowed a deduction for the taxable year in which the disqualifying disposition occurs for the compensation income of 2,000. Y is not allowed a deduction for the additional gain includible in E8217s income as a result of the redemption. (2) If an optionee transfers stock acquired through the optionee8217s exercise of a statutory option prior to the expiration of the applicable holding periods, paragraph (a) of this section continues to apply to the transfer of the stock pursuant to the exercise of the option if such transfer is not a disposition of the stock as defined in sect1.424-1(c) (for example, a transfer from a decedent to the decedent8217s estate or a transfer by bequest or inheritance). Similarly, a subsequent transfer by the executor, administrator, heir, or legatee is not a disqualifying disposition by the decedent. If a statutory option is exercised by the estate of the optionee or by a person who acquired the option by bequest or inheritance or by reason of the death of such optionee, see paragraph (c) of this section. If a statutory option is exercised by the individual to whom the option was granted and the individual dies before the expiration of the holding periods, see paragraph (d) of this section. (3) For special rules relating to the disqualifying disposition of a share of stock acquired by exercise of an incentive stock option, see sectsect1.422-5(b)(2) and 1.424-1(c)(3). (c) Exercise by estate . (1) If a statutory option is exercised by the estate of the individual to whom the option was granted (or by any person who acquired such option by bequest or inheritance or by reason of the death of such individual), paragraph (a) of this section applies to the transfer of stock pursuant to such exercise in the same manner as if the option had been exercised by the deceased optionee. Consequently, neither the estate nor such person is required to include any amount in gross income as a result of a transfer of stock pursuant to the exercise of the option. Paragraph (a) of this section applies even if the executor, administrator, or such person disposes of the stock so acquired before the expiration of the applicable holding periods as determined under sect1.422-1(a) or 1.423-1(a). This special rule does not affect the applicability of section 423(c), relating to the estate8217s or other qualifying person8217s recognition of compensation income, or section 1222, relating to what constitutes a short-term and long-term capital gain or loss. Paragraph (a) of this section also applies even if the executor, administrator, or such person does not exercise the option within three months after the death of the individual or is not employed as described in sect1.421-1(h), either when the option is exercised or at any time. However, paragraph (a) of this section does not apply to a transfer of shares pursuant to an exercise of the option by the estate or by such person unless the individual met the employment requirements described in sect1.421-1(h) either at the time of the individual8217s death or within three months before such time (or, if applicable, within the period described in sect1.422-1(a)(3)).Additionally, paragraph (a) of this section does not apply if the option is exercised by a person other than the executor or administrator, or other than a person who acquired the option by bequest or inheritance or by reason of the death of such deceased individual. For example, if the option is sold by the estate, paragraph (a) of this section does not apply to the transfer of stock pursuant to an exercise of the option by the buyer, but if the option is distributed by the administrator to an heir as part of the estate, paragraph (a) of this section applies to the transfer of stock pursuant to an exercise of the option by such heir. (d) Option exercised by the individual to whom the option was granted if the individual dies before expiration of the applicable holding periods . If a statutory option is exercised by the individual to whom the option was granted and such individual dies before the expiration of the applicable holding periods as determined under sect1.422-1(a) or 1.423-1(a), paragraph (a) of this section does not become inapplicable if the executor or administrator of the estate of such individual, or any person who acquired such stock by bequest or inheritance or by reason of the death of such individual, disposes of such stock before the expiration of such applicable holding periods. This rule does not affect the applicability of section 423(c), relating to the individual8217s recognition of compensation income, or section 1222, relating to what constitutes a short-term and long-term capital gain or loss. (f) Effective date 8212 (1) In general . These regulations are effective on August 3, 2004. (2) Reliance and transition period . For statutory options granted on or before June 9, 2003, taxpayers may rely on the 1984 proposed regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-122917-02 (68 FR 34344), or this section until the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring 6 months after August 3, 2004. For statutory options granted after June 9, 2003, and before the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after August 3, 2004, taxpayers may rely on either the REG-122917-02 or this section. Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 2005. Reliance on LR-279-81, REG-122917-02, or this section must be in its entirety, and all statutory options granted during the reliance period must be treated consistently. Par. 5. Section 1.422-1 is added to read as follows: sect1.422-1 Incentive stock options general rules. (a) Applicability of section 421(a) . (1)(i) Section 1.421-2(a) applies to the transfer of a share of stock to an individual pursuant to the individual8217s exercise of an incentive stock option if the following conditions are satisfied8212 (A) The individual makes no disposition of such share before the later of the expiration of the 2-year period from the date of grant of the option pursuant to which such share was transferred, or the expiration of the 1-year period from the date of transfer of such share to the individual and (B) At all times during the period beginning on the date of grant of the option and ending on the day 3 months before the date of exercise, the individual was an employee of either the corporation granting the option, a related corporation of such corporation, or a corporation (or a related corporation of such corporation) substituting or assuming a stock option in a transaction to which sect1.424-1(a) applies. (ii) For rules relating to the disposition of shares of stock acquired pursuant to the exercise of a statutory option, see sect1.424-1(c). For rules relating to the requisite employment relationship, see sect1.421-1(h). (2)(i) The holding period requirement of section 422(a)(1), described in paragraph (a)(1)(i)(A) of this section, does not apply to the transfer of shares by an insolvent individual described in this paragraph (a)(2). If an insolvent individual holds a share of stock acquired pursuant to the individual8217s exercise of an incentive stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary in any proceeding under the Bankruptcy Act or any other similar insolvency proceeding, neither such transfer, nor any other transfer of such share for the benefit of the individual8217s creditors in such proceeding is a disposition of such share for purposes of this paragraph (a). For purposes of this paragraph (a)(2), an individual is insolvent only if the individual8217s liabilities exceed the individual8217s assets or the individual is unable to satisfy the individual8217s liabilities as they become due. See section 422(c)(3). (ii) A transfer by the trustee or other fiduciary that is not treated as a disposition for purposes of this paragraph (a) may be a sale or exchange for purposes of recognizing capital gain or loss with respect to the share transferred. For example, if the trustee transfers the share to a creditor in an insolvency proceeding, capital gain or loss must be recognized by the insolvent individual to the extent of the difference between the amount realized from such transfer and the adjusted basis of such share. (iii) If any transfer by the trustee or other fiduciary (other than a transfer back to the insolvent individual) is not for the exclusive benefit of the creditors in an insolvency proceeding, then whether such transfer is a disposition of the share by the individual for purposes of this paragraph (a) is determined under sect1.424-1(c). Similarly, if the trustee or other fiduciary transfers the share back to the insolvent individual, any subsequent transfer of the share by such individual which is not made in respect of the insolvency proceeding may be a disposition of the share for purposes of this paragraph (a). (3) If the employee exercising an option ceased employment because of permanent and total disability, within the meaning of section 22(e)(3), 1 year is used instead of 3 months in the employment period requirement of paragraph (a)(1)(i)(B) of this section. (b) Failure to satisfy holding period requirements 8212(1) General rule . For general rules concerning a disqualifying disposition of a share of stock acquired pursuant to the exercise of an incentive stock option, see sect1.421-2(b)(1). (2)(i) Special rule . If an individual makes a disqualifying disposition of a share of stock acquired by the exercise of an incentive stock option, and if such disposition is a sale or exchange with respect to which a loss (if sustained) would be recognized to the individual, then, under this paragraph (b)(2)(i), the amount includible (determined without reduction for brokerage fees or other costs paid in connection with the disposition) in the gross income of such individual, and deductible from the income of the employer corporation (or a related corporation of such corporation, or of a corporation substituting or assuming the option in a transaction to which sect1.424-1(a) applies) as compensation attributable to the exercise of such option, shall not exceed the excess (if any) of the amount realized on such sale or exchange over the adjusted basis of such share. Subject to the special rule provided by this paragraph (b)(2)(i), the amount of compensation attributable to the exercise of the option is determined under section 83(a) see sect1.421-2(b)(1)(i). (ii) Limitation to special rule . The special rule described in paragraph (b)(2)(i) of this section does not apply if the disposition is a sale or exchange with respect to which a loss (if sustained) would not be recognized by the individual. Thus, for example, if a disqualifying disposition is a sale described in section 1091 (relating to loss from wash sales of stock or securities), a gift (or any other transaction which is not at arm8217s length), or a sale described in section 267(a)(1) (relating to sales between related persons), the special rule described in paragraph (b)(2)(i) of this section does not apply because a loss sustained in any such transaction would not be recognized. (3) Examples . The following examples illustrate the principles of this paragraph (b): Example 1 . Disqualifying disposition of vested stock . On June 1, 2006, X Corporation grants an incentive stock option to A, an employee of X Corporation, entitling A to purchase one share of X Corporation stock. On August 1, 2006, A exercises the option, and the share of X Corporation stock is transferred to A on that date. The option price is 100 (the fair market value of a share of X Corporation stock on June 1, 2006), and the fair market value of a share of X Corporation stock on August 1, 2006 (the date of transfer), is 200. The share transferred to A is transferable and not subject to a substantial risk of forfeiture. A makes a disqualifying disposition by selling the share on June 1, 2007, for 250. The amount of compensation attributable to A8217s exercise is 100 (the difference between the fair market value of the share at the date of transfer, 200, and the amount paid for the share, 100). Because the amount realized (250) is greater than the value of the share at transfer (200), paragraph (b)(2)(i) of this section does not apply and thus does not affect the amount includible as compensation in A8217s gross income and deductible by X. A must include in gross income for the taxable year in which the sale occurred 100 as compensation and 50 as capital gain (250, the amount realized from the sale, less A8217s basis of 200 (the 100 paid for the share plus the 100 increase in basis resulting from the inclusion of that amount in A8217s gross income as compensation attributable to the exercise of the option)). If the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162, for its taxable year in which the disqualifying disposition occurs, X Corporation is allowed a deduction of 100 for compensation attributable to A8217s exercise of the incentive stock option. Przykład 2. Disqualifying disposition of unvested stock . Assume the same facts as in Example 1 . except that the share of X Corporation stock received by A is subject to a substantial risk of forfeiture and not transferable for a period of six months after such exercise. Assume further that the fair market value of X Corporation stock is 225 on February 1, 2007, the date on which the six-month restriction lapses. Because section 83 does not apply for ordinary income tax purposes on the date of exercise, A cannot make an effective section 83(b) election at that time (although such an election is permissible for alternative minimum tax purposes). Additionally, at the time of the disposition, section 422 and sect1.422-1(a) no longer apply, and thus, section 83(a) is used to measure the consequences of the disposition, and the holding period for capital gain purposes begins on the vesting date, six months earlier. The amount of compensation attributable to A8217s exercise of the option and disqualifying disposition of the share is 125 (the difference between the fair market value of the share on the date that the restriction lapsed, 225, and the amount paid for the share, 100). Because the amount realized (225) is greater than the value of the share at transfer (200), paragraph (b)(2)(i) of this section does not apply and thus does not affect the amount includible as compensation in A8217s gross income and deductible by X. A must include 125 of compensation income and 25 of capital gain in gross income for the taxable year in which the disposition occurs (250, the amount realized from the sale, less A8217s basis of 225 (the 100 paid for the share plus the 125 increase in basis resulting from the inclusion of that amount of compensation in A8217s gross income)). If the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162, for its taxable year in which the disqualifying disposition occurs, X Corporation is allowed a deduction of 125 for the compensation attributable to A8217s exercise of the option. Example 3 . (i) Disqualifying disposition and application of special rule . Assume the same facts as in Example 1 . except that A sells the share for 150 to M. (ii) If the sale to M is a disposition that meets the requirements of paragraph (b)(2)(i) of this section, instead of 100 which otherwise would have been includible as compensation under sect1.83-7, under paragraph (b)(2)(i) of this section, A must include only 50 (the excess of the amount realized on such sale, 150, over the adjusted basis of the share, 100) in gross income as compensation attributable to the exercise of the incentive stock option. Because A8217s basis for the share is 150 (the 100 which A paid for the share, plus the 50 increase in basis resulting from the inclusion of that amount in A8217s gross income as compensation attributable to the exercise of the option), A realizes no capital gain or loss as a result of the sale. If the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162, for its taxable year in which the disqualifying disposition occurs, X Corporation is allowed a deduction of 50 for the compensation attributable to A8217s exercise of the option and disqualifying disposition of the share. (iii) Assume the same facts as in paragraph (i) of this Example 3 . except that 10 days after the sale to M, A purchases substantially identical stock. Because under section 1091(a) a loss (if it were sustained on the sale) would not be recognized on the sale, under paragraph (b)(2)(ii) of this section, the special rule described in paragraph (b)(2)(i) of this section does not apply. A must include 100 (the difference between the fair market value of the share on the date of transfer, 200, and the amount paid for the share, 100) in gross income as compensation attributable to the exercise of the option for the taxable year in which the disqualifying disposition occurred. A recognizes no capital gain or loss on the transaction. If the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162, for its taxable year in which the disqualifying disposition occurs X Corporation is allowed a 100 deduction for compensation attributable to A8217s exercise of the option and disqualifying disposition of the share. (iv) Assume the same facts as in paragraph (ii) of this Example 3 . except that A sells the share for 50. Under paragraph (b)(2)(i) of this section, A is not required to include any amount in gross income as compensation attributable to the exercise of the option. A is allowed a capital loss of 50 (the difference between the amount realized on the sale, 50, and the adjusted basis of the share, 100). X Corporation is not allowed any deduction attributable to A8217s exercise of the option and disqualifying disposition of the share. (c) Failure to satisfy employment requirement . Section 1.421-2(a) does not apply to the transfer of a share of stock pursuant to the exercise of an incentive stock option if the employment requirement, as determined under paragraph (a)(1)(i)(B) of this section, is not met at the time of the exercise of such option. Consequently, the effects of such a transfer are determined under the rules of sect1.83-7.For rules relating to the employment relationship, see sect1.421-1(h). Par. 6. Section 1.422-2 is added to read as follows: sect1.422-2 Incentive stock options defined. (a) Incentive stock option defined 8212(1) In general . The term incentive stock option means an option that meets the requirements of paragraph (a)(2) of this section on the date of grant. An incentive stock option is also subject to the 100,000 limitation described in sect1.422-4. An incentive stock option may contain a number of permissible provisions that do not affect the status of the option as an incentive stock option. See sect1.422-5 for rules relating to permissible provisions of an incentive stock option. (2) Option requirements . To qualify as an incentive stock option under this section, an option must be granted to an individual in connection with the individual8217s employment by the corporation granting such option (or by a related corporation as defined in sect1.421-1(i)(2)), and granted only for stock of any of such corporations. In addition, the option must meet all of the following requirements8212 (i) It must be granted pursuant to a plan that meets the requirements described in paragraph (b) of this section (ii) It must be granted within 10 years from the date of the adoption of the plan or the date such plan is approved by the stockholders, whichever is earlier (see paragraph (c) of this section) (iii) It must not be exercisable after the expiration of 10 years from the date of grant (see paragraph (d) of this section) (iv) It must provide that the option price per share is not less than the fair market value of the share on the date of grant (see paragraph (e) of this section) (v) By its terms, it must not be transferrable by the individual to whom the option is granted other than by will or the laws of descent and distribution, and must be exercisable, during such individual8217s lifetime, only by such individual (see sectsect1.421-1(b)(2) and 1.421-2(c)) and (vi) Except as provided in paragraph (f) of t his section, it must be granted to an individual who, at the time the option is granted, does not own stock possessing more than 10 percent of the total combined voting power of all classes of stock of the corporation employing such individual or of any related corporation of such corporation. (3) Amendment of option terms . Except as otherwise provided in sect1.424-1, the amendment of the terms of an incentive stock option may cause it to cease to be an option described in this section. If the terms of an option that has lost its status as an incentive stock option are subsequently changed with the intent to re-qualify the option as an incentive stock option, such change results in the grant of a new option on the date of the change. See sect1.424-1(e). (4) Terms provide option not an incentive stock option . If the terms of an option, when granted, provide that it will not be treated as an incentive stock option, such option is not treated as an incentive stock option. (b) Option plan 8212(1) In general . An incentive stock option must be granted pursuant to a plan that meets the requirements of this paragraph (b). The authority to grant other stock options or other stock-based awards pursuant to the plan, where the exercise of such other options or awards does not affect the exercise of incentive stock options granted pursuant to the plan, does not disqualify such incentive stock options. The plan must be in writing or electronic form, provided that such writing or electronic form is adequate to establish the terms of the plan. See sect1.422-5 for rules relating to permissible provisions of an incentive stock option. (2) Stockholder approval . (i) The plan required by this paragraph (b) must be approved by the stockholders of the corporation granting the incentive stock option within 12 months before or after the date such plan is adopted. Ordinarily, a plan is adopted when it is approved by the granting corporation8217s board of directors, and the date of the board8217s action is the reference point for determining whether stockholder approval occurs within the applicable 24-month period. However, if the board8217s action is subject to a condition (such as stockholder approval) or the happening of a particular event, the plan is adopted on the date the condition is met or the event occurs, unless the board8217s resolution fixes the date of approval as the date of the board8217s action. (ii) For purposes of paragraph (b)(2)(i) of this section, the stockholder approval must comply with the rules described in sect1.422-3. (iii) The provisions relating to the maximum aggregate number of shares to be issued under the plan (described in paragraph (b)(3) of this section) and the employees (or class or classes of employees) eligible to receive options under the plan (described in paragraph (b)(4) of this section) are the only provisions of a stock option plan that, if changed, must be re-approved by stockholders for purposes of section 422(b)(1). Any increase in the maximum aggregate number of shares that may be issued under the plan (other than an increase merely reflecting a change in the number of outstanding shares, such as a stock dividend or stock split), or change in the designation of the employees (or class or classes of employees) eligible to receive options under the plan is considered the adoption of a new plan requiring stockholder approval within the prescribed 24-month period. In addition, a change in the granting corporation or the stock available for purchase or award under the plan is considered the adoption of a new plan requiring new stockholder approval within the prescribed 24-month period. Any other changes in the terms of an incentive stock option plan are not considered the adoption of a new plan and, thus, do not require stockholder approval. (3) Maximum aggregate number of shares . (i) The plan required by this paragraph (b) must designate the maximum aggregate number of shares that may be issued under the plan through incentive stock options. If nonstatutory options or other stock-based awards may be granted, the plan may separately designate terms for each type of option or other stock-based awards and designate the maximum number of shares that may be issued under such option or other stock-based awards. Unless otherwise specified, all terms of the plan apply to all options and other stock-based awards that may be granted under the plan. (ii) A plan that merely provides that the number of shares that may be issued as incentive stock options under such plan may not exceed a stated percentage of the shares outstanding at the time of each offering or grant under such plan does not satisfy the requirement that the plan state the maximum aggregate number of shares that may be issued under the plan. However, the maximum aggregate number of shares that may be issued under the plan may be stated in terms of a percentage of the authorized, issued, or outstanding shares at the date of the adoption of the plan. The plan may specify that the maximum aggregate number of shares available for grants under the plan may increase annually by a specified percentage of the authorized, issued, or outstanding shares at the date of the adoption of the plan. A plan which provides that the maximum aggregate number of shares that may be issued as incentive stock options under the plan may change based on any other specified circumstances satisfies the requirements of this paragraph (b)(3) only if the stockholders approve an immediately determinable maximum aggregate number of shares that may be issued under the plan in any event. (iii) It is permissible for the plan to provide that, shares purchasable under the plan may be supplied to the plan through acquisitions of stock on the open market shares purchased under the plan and forfeited back to the plan shares surrendered in payment of the exercise price of an option shares withheld for payment of applicable employment taxes andor withholding obligations resulting from the exercise of an option. (iv) If there is more than one plan under which incentive stock options may be granted and stockholders of the granting corporation merely approve a maximum aggregate number of shares that are available for issuance under such plans, the stockholder approval requirements described in paragraph (b)(2) of this section are not satisfied. A separate maximum aggregate number of shares available for issuance pursuant to incentive stock options must be approved for each plan. (4) Designation of employees . The plan described in this paragraph (b), as adopted and approved, must indicate the employees (or class or classes of employees) eligible to receive the options or other stock-based awards to be granted under the plan. This requirement is satisfied by a general designation of the employees (or the class or classes of employees) eligible to receive options or other stock-based awards under the plan. Designations such as 8220key employees of the grantor corporation8221 8220all salaried employees of the grantor corporation and its subsidiaries, including subsidiaries which become such after adoption of the plan8221 or 8220all employees of the corporation8221 meet this requirement. This requirement is considered satisfied even though the board of directors, another group, or an individual is given the authority to select the particular employees who are to receive options or other stock-based awards from a described class and to determine the number of shares to be optioned or granted to each such employee. If individuals other than employees may be granted options or other stock-based awards under the plan, the plan must separately designate the employees or classes of employees eligible to receive incentive stock options. (5) Conflicting option terms . An option on stock available for purchase or grant under the plan is treated as having been granted pursuant to a plan even if the terms of the option conflict with the terms of the plan, unless such option is granted to an employee who is ineligible to receive options under the plan, options have been granted on stock in excess of the aggregate number of shares which may be issued under the plan, or the option provides otherwise. (6) The following examples illustrate the principles of this paragraph (b): Example 1 . Stockholder approval . (i) S Corporation is a subsidiary of P Corporation, a publicly traded corporation. On January 1, 2006, S adopts a plan under which incentive stock options for S stock are granted to S employees. (ii) To meet the requirements of paragraph (b)(2) of this section, the plan must be approved by the stockholders of S (in this case, P) within 12 months before or after January 1, 2006. (iii) Assume the same facts as in paragraph (i) of this Example 1 . Assume further that the plan was approved by the stockholders of S (in this case, P) on March 1, 2006. On January 1, 2008, S changes the plan to provide that incentive stock options for P stock will be granted to S employees under the plan. Because there is a change in the stock available for grant under the plan, the change is considered the adoption of a new plan that must be approved by the stockholders of P within 12 months before or after January 1, 2008. Example 2 . Stockholder approval . (i) Assume the same facts as in paragraph (i) of Example 1 . except that on March 15, 2007, P completely disposes of its interest in S. Thereafter, S continues to grant options for S stock to S employees under the plan. (ii) The new S options are granted under a plan that meets the stockholder approval requirements of paragraph (b)(2) of this section without regard to whether S seeks approval of the plan from the stockholders of S after P disposes of its interest in S. (iii) Assume the same facts as in paragraph (i) of this Example 2 . except that under the plan as adopted on January 1, 2006, only options for P stock are granted to S employees. Assume further that after P disposes of its interest in S, S changes the plan to provide for the grant of options for S stock to S employees. Because there is a change in the stock available for purchase or grant under the plan, under paragraph (b)(2)(iii) of this section, the stockholders of S must approve the plan within 12 months before or after the change to the plan to meet the stockholder approval requirements of paragraph (b) of this section. Example 3 . Stockholder approval .(i) Corporation X maintains a plan under which incentive stock options may be granted to all eligible employees. Corporation Y does not maintain an incentive stock option plan. On May 15, 2006, Corporation X and Corporation Y consolidate under state law to form one corporation. The new corporation will be named Corporation Y. The consolidation agreement describes the Corporation X plan, including the maximum aggregate number of shares available for issuance pursuant to incentive stock options after the consolidation and the employees eligible to receive options under the plan. Additionally, the consolidation agreement states that the plan will be continued by Corporation Y after the consolidation and incentive stock options will be issued by Corporation Y. The consolidation agreement is unanimously approved by the shareholders of Corporations X and Y on May 1, 2006. Corporation Y assumes the plan formerly maintained by Corporation X and continues to grant options under the plan to all eligible employees. (ii) Because there is a change in the granting corporation (from Corporation X to Corporation Y), under paragraph (b)(2)(iii) of this section, Corporation Y is considered to have adopted a new plan. Because the plan is fully described in the consolidation agreement, including the maximum aggregate number of shares available for issuance pursuant to incentive stock options and employees eligible to receive options under the plan, the approval of the consolidation agreement by the shareholders constitutes approval of the plan. Thus, the shareholder approval of the consolidation agreement satisfies the shareholder approval requirements of paragraph (b)(2) of this section, and the plan is considered to be adopted by Corporation Y and approved by its shareholders on May 1, 2006. Example 4 . Maximum aggregate number of shares . X Corporation maintains a plan under which statutory options and nonstatutory options may be granted. The plan designates the number of shares that may be used for incentive stock options. Because the maximum aggregate number of shares that will be used for incentive stock options is designated in the plan, the requirements of paragraph (b)(3) of this section are satisfied. Example 5 . Maximum aggregate number of shares . Y Corporation adopts an incentive stock option plan on November 1, 2006. On that date, there are two million outstanding shares of Y Corporation stock. The plan provides that the maximum aggregate number of shares that may be issued under the plan may not exceed 15 of the outstanding number of shares of Y Corporation on November 1, 2006. Because the maximum aggregate number of shares that may be issued under the plan is designated in the plan, the requirements of paragraph (b)(3) of this section are met. Example 6 . Maximum aggregate number of shares . (i) B Corporation adopts an incentive stock option plan on March 15, 2005. The plan provides that the maximum aggregate number of shares available for issuance under the plan is 50,000, increased on each anniversary date of the adoption of the plan by 5 percent of the then-outstanding shares. (ii) Because the maximum aggregate number of shares is not designated under the plan, the requirements of paragraph (b)(3) of this section are not met. (iii) Assume the same facts as in paragraph (i) of this Example 6 . except that the plan provides that the maximum aggregate number of shares available under the plan is the lesser of (a) 50,000 shares, increased each anniversary date of the adoption of the plan by 5 percent of the then-outstanding shares, or (b) 200,000 shares. Because the maximum aggregate number of shares that may be issued under the plan is designated as the lesser of one of two numbers, one of which provides an immediately determinable maximum aggregate number of shares that may be issued under the plan in any event, the requirements of paragraph (b)(3) of this section are met. (c) Duration of option grants under the plan . An incentive stock option must be granted within 10 years from the date that the plan under which it is granted is adopted or the date such plan is approved by the stockholders, whichever is earlier. To grant incentive stock options after the expiration of the 10-year period, a new plan must be adopted and approved. (d) Period for exercising options . An incentive stock option, by its terms, must not be exercisable after the expiration of 10 years from the date such option is granted, or 5 years from the date such option is granted to an employee described in paragraph (f) of this section. An option that does not contain such a provision when granted is not an incentive stock option. (e) Option price . (1) Except as provided by paragraph (e)(2) of this section, the option price of an incentive stock option must not be less than the fair market value of the stock subject to the option at the time the option is granted. The option price may be determined in any reasonable manner, including the valuation methods permitted under sect20.2031-2 of this chapter, so long as the minimum price possible under the terms of the option is not less than the fair market value of the stock on the date of grant. For general rules relating to the option price, see sect1.421-1(e). For rules relating to the determination of when an option is granted, see sect1.421-1(c). (2)(i) If a share of stock is transferred to an individual pursuant to the exercise of an option which fails to qualify as an incentive stock option merely because there was a failure of an attempt, made in good faith, to meet the option price requirements of paragraph (e)(1) of this section, the requirements of such paragraph are considered to have been met. Whether there was a good-faith attempt to set the option price at not less than the fair market value of the stock subject to the option at the time the option was granted depends on the relevant facts and circumstances. (ii) For publicly held stock that is actively traded on an established market at the time the option is granted, determining the fair market value of such stock by the appropriate method described in sect20.2031-2 of this chapter establishes that a good-faith attempt to meet the option price requirements of this paragraph (e) was made. (iii) For non-publicly traded stock, if it is demonstrated, for example, that the fair market value of the stock at the date of grant was based upon an average of the fair market values as of such date set forth in the opinions of completely independent and well-qualified experts, such a demonstration generally establishes that there was a good-faith attempt to meet the option price requirements of this paragraph (e). The optionee8217s status as a majority or minority stockholder may be taken into consideration. (iv) Regardless of whether the stock offered under an option is publicly traded, a good-faith attempt to meet the option price requirements of this paragraph (e) is not demonstrated unless the fair market value of the stock on the date of grant is determined with regard to nonlapse restrictions (as defined in sect1.83-3(h)) and without regard to lapse restrictions (as defined in sect1.83-3(i)). (v) Amounts treated as interest and amounts paid as interest under a deferred payment arrangement are not includible as part of the option price. See sect1.421-1(e)(1). An attempt to set the option price at not less than fair market value is not regarded as made in good faith where an adjustment of the option price to reflect amounts treated as interest results in the option price being lower than the fair market value on which the option price was based. (3) Notwithstanding that the option price requirements of paragraphs (e)(1) and (2) of this section are satisfied by an option granted to an employee whose stock ownership exceeds the limitation provided by paragraph (f) of this section, such option is not an incentive stock option when granted unless it also complies with paragraph (f) of this section. If the option, when granted, does not comply with the requirements described in paragraph (f) of this section, such option can never become an incentive stock option, even if the employee8217s stock ownership does not exceed the limitation of paragraph (f) of this section when such option is exercised. (f) Options granted to certain stockholders . (1) If, immediately before an option is granted, an individual owns (or is treated as owning) stock possessing more than 10 percent of the total combined voting power of all classes of stock of the corporation employing the optionee or of any related corporation of such corporation, then an option granted to such individual cannot qualify as an incentive stock option unless the option price is at least 110 percent of the stock8217s fair market value on the date of grant and such option by its terms is not exercisable after the expiration of 5 years from the date of grant. For purposes of determining the minimum option price for purposes of this paragraph (f), the rules described in paragraph (e)(2) of this section, relating to the good-faith determination of the option price, do not apply. (2) For purposes of determining the stock ownership of the optionee, the stock attribution rules of sect1.424-1(d) apply. Stock that the optionee may purchase under outstanding options is not treated as stock owned by the individual. The determination of the percentage of the total combined voting power of all classes of stock of the employer corporation (or of its related corporations) that is owned by the optionee is made with respect to each such corporation in the related group by comparing the voting power of the shares owned (or treated as owned) by the optionee to the aggregate voting power of all shares of each such corporation actually issued and outstanding immediately before the grant of the option to the optionee. The aggregate voting power of all shares actually issued and outstanding immediately before the grant of the option does not include the voting power of treasury shares or shares authorized for issue under outstanding options held by the individual or any other person. (3) Examples . The rules of this paragraph (f) are illustrated by the following examples: Example 1 . (i) E, an employee of M Corporation, owns 15,000 shares of M Corporation common stock, which is the only class of stock outstanding. M has 100,000 shares of its common stock outstanding. On January 1, 2005, when the fair market value of M stock is 100, E is granted an option with an option price of 100 and an exercise period of 10 years from the date of grant. (ii) Because E owns stock possessing more than 10 percent of the total combined voting power of all classes of M Corporation stock, M cannot grant an incentive stock option to E unless the option is granted at an option price of at least 110 percent of the fair market value of the stock subject to the option and the option, by its terms, expires no later than 5 years from its date of grant. The option granted to E fails to meet the option-price and term requirements described in paragraph (f)(1) of this section and, thus, the option is not an incentive stock option. (iii) Assume the same facts as in paragraph (i) of this Example 1 . except that E8217s father and brother each owns 7,500 shares of M Corporation stock, and E owns no M stock in E8217s own name. Because under the attribution rules of sect1.424-1(d), E is treated as owning stock held by E8217s parents and siblings, M cannot grant an incentive stock option to E unless the option price is at least 110 percent of the fair market value of the stock subject to the option, and the option, by its terms, expires no later than 5 years from the date of grant. Przykład 2. Assume the same facts as in paragraph (i) of this Example 1 . Assume further that M is a subsidiary of P Corporation. Regardless of whether E owns any P stock and the number of P shares outstanding, if P Corporation grants an option to E which purports to be an incentive stock option, but which fails to meet the 110-percent-option-price and 5-year-term requirements, the option is not an incentive stock option because E owns more than 10 percent of the total combined voting power of all classes of stock of a related corporation of P Corporation ( i. e. . M Corporation). An individual who owns (or is treated as owning) stock in excess of the ownership specified in paragraph (f)(1) of this section, in any corporation in a group of corporations consisting of the employer corporation and its related corporations, cannot be granted an incentive stock option by any corporation in the group unless such option meets the 110-percent-option-price and 5-year-term requirements of paragraph (f)(1) of this section. Example 3 . (i) F is an employee of R Corporation. R has only one class of stock, of which 100,000 shares are issued and outstanding. F owns no stock in R Corporation or any related corporation of R Corporation. On January 1, 2005, R grants a 10-year incentive stock option to F to purchase 50,000 shares of R stock at 3 per share, the fair market value of R stock on the date of grant of the option. On April 1, 2005, F exercises half of the January option and receives 25,000 shares of R stock that previously were not outstanding. On July 1, 2005, R grants a second 50,000 share option to F which purports to be an incentive stock option. The terms of the July option are identical to the terms of the January option, except that the option price is 3.25 per share, which is the fair market value of R stock on the date of grant of the July option. (ii) Because F does not own more than 10 of the total combined voting power of all classes of stock of R Corporation or any related corporation on the date of the grant of the January option and the pricing requirements of paragraph (e) of this section are satisfied on the date of grant of such option, the unexercised portion of the January option remains an incentive stock option regardless of the changes in F8217s percentage of stock ownership in R after the date of grant. However, the July option is not an incentive stock option because, on the date that it is granted, F owns 20 percent (25,000 shares owned by F divided by 125,000 shares of R stock issued and outstanding) of the total combined voting power of all classes of R Corporation stock and, thus the pricing requirements of paragraph (f)(1) of this section are not met. (iii) Assume the same facts as in paragraph (i) of this Example 3 except that the partial exercise of the January incentive stock option on April 1, 2003, is for only 10,000 shares. Under these circumstances, the July option is an incentive stock option, because, on the date of grant of the July option, F does not own more than 10 percent of the total combined voting power (10,000 shares owned by F divided by 110,000 shares of R issued and outstanding) of all classes of R Corporation stock. sect1.422-4 Removed (a) 100,000 per year limitation 8212(1) General rule . An option that otherwise qualifies as an incentive stock option nevertheless fails to be an incentive stock option to the extent that the 100,000 limitation described in paragraph (a)(2) of this section is exceeded. (2) 100,000 per year limitation . To the extent that the aggregate fair market value of stock with respect to which an incentive stock option (determined without regard to this section) is exercisable for the first time by any individual during any calendar year (under all plans of the employer corporation and related corporations) exceeds 100,000, such option is treated as a nonstatutory option. See sect1.83-7 for rules applicable to nonstatutory options. (b) Application . To determine whether the limitation described in paragraph (a)(2) of this section has been exceeded, the following rules apply: (1) An option that does not meet the requirements of sect1.422-2 when granted (including an option which, when granted, contains terms providing that it will not be treated as an incentive stock option) is disregarded. See sect1.422-2(a)(4). (2) The fair market value of stock is determined as of the date of grant of the option for such stock. (3) Except as otherwise provided in paragraph (b)(4) of this section, options are taken into account in the order in which they are granted. (4) For purposes of this section, an option is considered to be first exercisable during a calendar year if the option will become exercisable at any time during the year assuming that any condition on the optionee8217s ability to exercise the option related to the performance of services is satisfied. If the optionee8217s ability to exercise the option in the year is subject to an acceleration provision, then the option is considered first exercisable in the calendar year in which the acceleration provision is triggered. After an acceleration provision is triggered, the options subject to such provision are then taken into account in accordance with paragraph (b)(3) of this section for purposes of applying the limitation described in paragraph (a)(2) of this section to all options first exercisable during a calendar year. However, because an acceleration provision is not taken into account prior to its triggering, an incentive stock option that becomes exercisable for the first time during a calendar year by operation of such a provision does not affect the application of the 100,000 limitation with respect to any option (or portion thereof) exercised prior to such acceleration. For purposes of this paragraph (b)(4), an acceleration provision includes, for example, a provision that accelerates the exercisability of an option on a change in ownership or control or a provision that conditions exercisability on the attainment of a performance goal. See paragraph (d), Example 4 of this section. (5)(i) An option (or portion thereof) is disregarded if, prior to the calendar year during which it would otherwise have become exercisable for the first time, the option (or portion thereof) is modified and thereafter ceases to be an incentive stock option described in sect1.422-2, is canceled, or is transferred in violation of sect1.421-1(b)(2). (ii) If an option (or portion thereof) is modified, canceled, or transferred at any other time, such option (or portion thereof) is treated as outstanding according to its original terms until the end of the calendar year during which it would otherwise have become exercisable for the first time. (6) A disqualifying disposition has no effect on the determination of whether an option exceeds the 100,000 limitation. (c) Bifurcation 8212 (1) Options . The application of the rules described in paragraph (b) of this section may result in an option being treated, in part, as an incentive stock option and, in part, as a nonstatutory option. See sect1.83-7 for the treatment of nonstatutory options. (2) Stock . A corporation may issue a separate certificate for incentive option stock or designate such stock as incentive stock option stock in the corporation8217s transfer records or plan records. In such a case, the issuance of separate certificates or designation in the corporation8217s transfer records or plan records is not a modification under sect1.424-1(e). In the absence of such an issuance or designation, shares are treated as first purchased under an incentive stock option to the extent of the 100,000 limitation, and the excess shares are treated as purchased under a nonstatutory option. See sect1.83-7 for the treatment of nonstatutory options. (d) Examples . The following examples illustrate the principles of this section. In each of the following examples E is an employee of X Corporation. The examples are as follows: Example 1 . General rule . Effective January 1, 2004, X Corporation adopts a plan under which incentive stock options may be granted to its employees. On January 1, 2004, and each succeeding January 1 through January 1, 2017, E is granted immediately exercisable options for X Corporation stock with a fair market value of 100,000 determined on the date of grant. The options qualify as incentive stock options (determined without regard to this section). On January 1, 2017, E exercises all of the options. Because the 100,000 limitation has not been exceeded during any calendar year, all of the options are treated as incentive stock options. Przykład 2. Order of grant . X Corporation is a parent corporation of Y Corporation, which is a parent corporation of Z Corporation. Each corporation has adopted its own separate plan, under which an employee of any member of the corporate group may be granted options for stock of any member of the group. On January 1, 2004, X Corporation grants E an incentive stock option (determined without regard to this section) for stock of Y Corporation with a fair market value of 100,000 on the date of grant. On December 31, 2004, Y Corporation grants E an incentive stock option (determined without regard to this section) for stock of Z Corporation with a fair market value of 75,000 as of the date of grant. Both of the options are immediately exercisable. For purposes of this section, options are taken into account in the order in which granted using the fair market value of stock as of the date on the option is granted. During calendar year 2004, the aggregate fair market value of stock with respect to which E8217s options are exercisable for the first time exceeds 100,000. Therefore, the option for Y Corporation stock is treated as an incentive stock option, and the option for Z Corporation stock is treated as a nonstatutory option. Example 3 . Acceleration provision . (i) In 2004, X Corporation grants E three incentive stock options (determined without regard to this section) to acquire stock with an aggregate fair market value of 150,000 on the date of grant. The dates of grant, the fair market value of the stock (as of the applicable date of grant) with respect to which the options are exercisable, and the years in which the options are first exercisable (without regard to acceleration provisions) are as follows: (ii) In July of 2004, a change in control of X Corporation occurs, and, under the terms of its option plan, all outstanding options become immediately exercisable. Under the rules of this section, Option 1 is treated as an incentive stock option in its entirety Option 2 exceeds the 100,000 aggregate fair market value limitation for calendar year 2004 by 10,000 (Option 18217s 60,000 Option 28217s 50,000 110,000) and is, therefore, bifurcated into an incentive stock option for stock with a fair market value of 40,000 as of the date of grant and a nonstatutory option for stock with a fair market value of 10,000 as of the date of grant. Option 3 is treated as a nonstatutory option in its entirety. Example 4 . Exercise of option and acceleration provision . (i) In 2004, X Corporation grants E three incentive stock options (determined without regard to this section) to acquire stock with an aggregate fair market value of 120,000 on the date of grant. The dates of grant, the fair market value of the stock (as of the applicable date of grant) with respect to which the options are exercisable, and the years in which the options are first exercisable (without regard to acceleration provisions) are as follows: Fair Market Value of Stock (ii) On June 1, 2005, E exercises Option 3. At the time of exercise of Option 3, the fair market value of X stock (at the time of grant) with respect to which options held by E are first exercisable in 2005 does not exceed 100,000. On September 1, 2005, a change of control of X Corporation occurs, and, under the terms of its option plan, Option 2 becomes immediately exercisable. Under the rules of this section, because E8217s exercise of Option 3 occurs before the change of control and the effects of an acceleration provision are not taken into account until it is triggered, Option 3 is treated as an incentive stock option in its entirety. Option 1 is treated as an incentive stock option in its entirety. Option 2 is bifurcated into an incentive stock option for stock with a fair market value of 20,000 on the date of grant and a nonstatutory option for stock with a fair market value of 20,000 on the date of grant because it exceeds the 100,000 limitation for 2003 by 20,000 (Option 1 for 60,000 Option 3 for 20,000 Option 2 for 40,000 120,000). (iii) Assume the same facts as in paragraph (ii) of this Example 4 . except that the change of control occurs on May 1, 2005. Because options are taken into account in the order in which they are granted, Option 1 and Option 2 are treated as incentive stock options in their entirety. Because the exercise of Option 3 (on June 1, 2005) takes place after the acceleration provision is triggered, Option 3 is treated as a nonstatutory option in its entirety. Example 5 . Cancellation of option . (i) In 2004, X Corporation grants E three incentive stock options (determined without regard to this section) to acquire stock with an aggregate fair market value of 140,000 as of the date of grant. The dates of grant, the fair market value of the stock (as of the applicable date of grant) with respect to which the options are exercisable, and the years in which the options are first exercisable (without regard to acceleration provisions) are as follows: Fair Market Value of Stock (ii) On December 31, 2004, Option 2 is canceled. Because Option 2 is canceled before the calendar year during which it would have become exercisable for the first time, it is disregarded. As a result, Option 1 and Option 3 are treated as incentive stock options in their entirety. (iii) Assume the same facts as in paragraph (ii) of this Example 5 . except that Option 2 is canceled on January 1, 2005. Because Option 2 is not canceled prior to the calendar year during which it would have become exercisable for the first time (2005), it is treated as an outstanding option for purposes of determining whether the 100,000 limitation for 2005 has been exceeded. Because options are taken into account in the order in which granted, Option 1 is treated as an incentive stock option in its entirety. Because Option 3 exceeds the 100,000 limitation by 40,000 (Option 1 for 60,000 Option 2 for 40,000 Option 3 for 40,000 140,000), it is treated as a nonstatutory option in its entirety. (iv) Assume the same facts as in paragraph (i) of this Example 5 . except that on January 1, 2005, E exercises Option 2 and immediately sells the stock in a disqualifying disposition. A disqualifying disposition has no effect on the determination of whether the underlying option is considered outstanding during the calendar year during which it is first exercisable. Because options are taken into account in the order in which granted, Option 1 is treated as an incentive stock option in its entirety. Because Option 3 exceeds the 100,000 limitation by 40,000 (Option 1 for 60,000 Option 2 for 40,000 Option 3 for 40,000 140,000), it is treated as a nonstatutory option in its entirety. Example 6 . Designation of stock . On January 1, 2004, X grants E an immediately exercisable incentive stock option (determined without regard to this section) to acquire X stock with a fair market value of 150,000 on that date. Under the rules of this section, the option is bifurcated and treated as an incentive stock option for X stock with a fair market value of 100,000 and a nonstatutory option for X stock with a fair market value of 50,000. In these circumstances, X may designate the stock that is treated as stock acquired pursuant to the exercise of an incentive stock option by issuing a separate certificate (or certificates) for 100,000 of stock and identifying such certificates as Incentive Stock Option Stock in its transfer records. In the absence of such a designation (or a designation in the corporation8217s transfer records or the plan records) shares with a fair market value of 100,000 are deemed purchased first under an incentive stock option, and shares with a fair market value of 50,000 are deemed purchased under a nonstatutory option. Par. 10. Section 1.422-5 is added to read as follows: sect1.422-5 Permissible provisions . (a) General rule . An option that otherwise qualifies as an incentive stock option does not fail to be an incentive stock option merely because such option contains one or more of the provisions described in paragraphs (b), (c), and (d) of this section. (b) Cashless exercise . (1) An option does not fail to be an incentive stock option merely because the optionee may exercise the option with previously acquired stock of the corporation that granted the option or stock of the corporation whose stock is being offered for purchase under the option. For special rules relating to the use of statutory option stock to pay the option price of an incentive stock option, see sect1.424-1(c)(3). (2) All shares acquired through the exercise of an incentive stock option are individually subject to the holding period requirements described in sect1.422-1(a) and the disqualifying disposition rules of sect1.422-1(b), regardless of whether the option is exercised with previously acquired stock of the corporation that granted the option or stock of the corporation whose stock is being offered for purchase under the option. If an incentive stock option is exercised with such shares, and the exercise results in the basis allocation described in paragraph (b)(3) of this section, the optionee8217s disqualifying disposition of any of the stock acquired through such exercise is treated as a disqualifying disposition of the shares with the lowest basis. (3) If the exercise of an incentive stock option with previously acquired shares is comprised in part of an exchange to which section 1036 (and so much of section 1031 as relates to section 1036) applies, then: (i) The optionee8217s basis in the incentive stock option shares received in the section 1036 exchange is the same as the optionee8217s basis in the shares surrendered in the exchange, increased, if applicable, by any amount included in gross income as compensation pursuant to sections 421 through 424 or section 83. Except for purposes of sect1.422-1(a), the holding period of the shares is determined under section 1223. For purposes of sect1.422-1 and sections 421(b) and 83 and the regulations thereunder, the amount paid for the shares purchased under the option is the fair market value of the shares surrendered on the date of the exchange. (ii) The optionee8217s basis in the incentive stock option shares not received pursuant to the section 1036 exchange is zero. For all purposes, the holding period of such shares begins as of the date that such shares are transferred to the optionee. For purposes of sect1.422-1(b) and sections 421(b) and 83 and the regulations thereunder, the amount paid for the shares is considered to be zero. (c) Additional compensation . An option does not fail to be an incentive stock option merely because the optionee has the right to receive additional compensation, in cash or property, when the option is exercised, provided such additional compensation is includible in income under section 61 or section 83. The amount of such additional compensation may be determined in any manner, including by reference to the fair market value of the stock at the time of exercise or to the option price. (d) Option subject to a condition . (1) An option does not fail to be an incentive stock option merely because the option is subject to a condition, or grants a right, that is not inconsistent with the requirements of sectsect1.422-2 and 1.422-4. (2) An option that includes an alternative right is not an incentive stock option if the requirements of sect1.422-2 are effectively avoided by the exercise of the alternative right. For example, an alternative right extending the option term beyond ten years, setting an option price below fair market value, or permitting transferability prevents an option from qualifying as an incentive stock option. If either of two options can be exercised, but not both, each such option is a disqualifying alternative right with respect to the other, even though one or both options would individually satisfy the requirements of sectsect1.422-2, 1.422-4, and this section. (3) An alternative right to receive a taxable payment of cash andor property in exchange for the cancellation or surrender of the option does not disqualify the option as an incentive stock option if the right is exercisable only when the then fair market value of the stock exceeds the exercise price of the option and the option is otherwise exercisable, the right is transferable only when the option is otherwise transferable, and the exercise of the right has economic and tax consequences no more favorable than the exercise of the option followed by an immediate sale of the stock. For this purpose, the exercise of the alternative right does not have the same economic and tax consequences if the payment exceeds the difference between the then fair market value of the stock and the exercise price of the option. (e) Examples . The principles of this section are illustrated by the following examples: Example 1 . On June 1, 2004, X Corporation grants an incentive stock option to A, an employee of X Corporation, entitling A to purchase 100 shares of X Corporation common stock at 10 per share. The option provides that A may exercise the option with previously acquired shares of X Corporation common stock. X Corporation has only one class of common stock outstanding. Under the rules of section 83, the shares transferable to A through the exercise of the option are transferable and not subject to a substantial risk of forfeiture. On June 1, 2005, when the fair market value of an X Corporation share is 25, A uses 40 shares of X Corporation common stock, which A had purchased on the open market on June 1, 2002, for 5 per share, to pay the full option price. After exercising the option, A owns 100 shares of incentive stock option stock. Under section 1036 (and so much of section 1031 as relates to section 1036), 40 of the shares have a 200 aggregate carryover basis (the 5 purchase price x 40 shares) and a three-year holding period for purposes of determining capital gain, and 60 of the shares have a zero basis and a holding period beginning on June 1, 2005, for purposes of determining capital gain. All 100 shares have a holding period beginning on June 1, 2005, for purposes of determining whether the holding period requirements of sect1.422-1(a) are met. Przykład 2. Assume the same facts as in Example 1 . Assume further that, on September 1, 2005, A sells 75 of the shares that A acquired through exercise of the incentive stock option for 30 per share. Because the holding period requirements were not satisfied, A made a disqualifying disposition of the 75 shares on September 1, 2005. Under the rules of paragraph (b)(2) and (b)(3) of this section, A has sold all 60 of the non-section-1036 shares and 15 of the 40 section-1036 shares. Therefore, under paragraph (b)(3) of this section and section 83(a), the amount of compensation attributable to A8217s exercise of the option and subsequent disqualifying disposition of 75 shares is 1,500 (the difference between the fair market value of the stock on the date of transfer, 1,875 (75 shares at 25 per share), and the amount paid for the stock, 375 (60 shares at 0 per share plus 15 shares at 25 per share)). In addition, A must recognize a capital gain of 675, which consists of 375 (450, the amount realized from the sale of 15 shares, less A8217s basis of 75) plus 300 (1,800, the amount realized from the sale of 60 shares, less A8217s basis of 1,500 resulting from the inclusion of that amount in income as compensation). Accordingly, A must include in gross income for the taxable year in which the sale occurs 1,500 as compensation and 675 as capital gain. For its taxable year in which the disqualifying disposition occurs, if otherwise allowable under section 162 and if the requirements of sect1.83-6(a) are met, X Corporation is allowed a deduction of 1,500 for the compensation paid to A. Example 3.Assume the same facts as in Example 2 . except that, instead of selling the 75 shares of incentive stock option stock on September 1, 2005, A uses those shares to exercise a second incentive stock option. The second option was granted to A by X Corporation on January 1, 2005, entitling A to purchase 100 shares of X Corporation common stock at 22.50 per share. As in Example 2 . A has made a disqualifying disposition of the 75 shares of stock pursuant to sect1.424-1(c). Under paragraph (b) of this section, A has disposed of all 60 of the non-section-1036 shares and 15 of the 40 section-1036 shares. Therefore, pursuant to paragraph (b)(3) of this section and section 83(a), the amount of compensation attributable to A8217s exercise of the first option and subsequent disqualifying disposition of 75 shares is 1,500 (the difference between the fair market value of the stock on the date of transfer, 1,875 (75 shares at 25 per share), and the amount paid for the stock, 375 (60 shares at 0 per share plus 15 shares at 25 per share)). Unlike Example 2 . A does not recognize any capital gain as a result of exercising the second option because, for all purposes other than the determination of whether the exercise is a disposition pursuant to section 424(c), the exercise is considered an exchange to which section 1036 applies. Accordingly, A must include in gross income for the taxable year in which the disqualifying disposition occurs 1,500 as compensation. If the requirements of sect83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162, for its taxable year in which the disqualifying disposition occurs, X Corporation is allowed a deduction of 1,500 for the compensation paid to A. After exercising the second option, A owns a total of 125 shares of incentive stock option stock. Under section 1036 (and so much of section 1031 as relates to section 1036), the 100 8220new8221 shares of incentive stock option stock have the following bases and holding periods: 15 shares have a 75 carryover basis and a three-year-and-three-month holding period for purposes of determining capital gain, 60 shares have a 1,500 basis resulting from the inclusion of that amount in income as compensation and a three-month holding period for purposes of determining capital gain, and 25 shares have a zero basis and a holding period beginning on September 1, 2005, for purposes of determining capital gain. All 100 shares have a holding period beginning on September 1, 2005, for purposes of determining whether the holding period requirements of sect1.422-1(a) are met. Example 4 . Assume the same facts as in Example 2 . except that, instead of selling the 75 shares of incentive stock option stock on September 1, 2005, A uses those shares to exercise a nonstatutory option. The nonstatutory option was granted to A by X Corporation on January 1, 2005, entitling A to purchase 100 shares of X Corporation common stock at 22.50 per share. Unlike Example 3 . A has not made a disqualifying disposition of the 75 shares of stock. After exercising the nonstatutory option, A owns a total of 100 shares of incentive stock option stock and 25 shares of nonstatutory stock option stock. Under section 1036 (and so much of section 1031 as relates to section 1036), the 75 new shares of incentive stock option stock have the same basis and holding period as the 75 old shares used to exercise the nonstatutory option. The additional 25 shares of stock received upon exercise of the nonstatutory option are taxed under the rules of section 83(a). Accordingly, A must include in gross income for the taxable year in which the transfer of such shares occurs 750 (25 shares at 30 per share) as compensation. A8217s basis in such shares is the same as the amount included in gross income. For its taxable year in which the transfer occurs, X Corporation is allowed a deduction of 750 for the compensation paid to A to the extent the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162. Example 5 . Assume the same facts in Example 1 . except that the shares transferred pursuant to the exercise of the incentive stock option are subject to a substantial risk of forfeiture and not transferable (substantially nonvested) for a period of six months after such transfer. Assume further that the shares that A uses to exercise the incentive stock option are similarly restricted. Such shares were transferred to A on January 1, 2005, through A8217s exercise of a nonstatutory stock option which was granted to A on January 1, 2004. A paid 5 per share for the stock when its fair market value was 22.50 per share. A did not file a section 83(b) election to include the 700 spread (the difference between the option price and the fair market value of the stock on date of exercise of the nonstatutory option) in gross income as compensation. After exercising the incentive stock option with the 40 substantially-nonvested shares, A owns 100 shares of substantially-nonvested incentive stock option stock. Section 1036 (and so much of section 1031 as relates to section 1036) applies to the 40 shares exchanged in exercise of the incentive stock option. However, pursuant to section 83(g), the stock received in such exchange, because it is incentive stock option stock, is not subject to restrictions and conditions substantially similar to those to which the stock given in such exchange was subject. For purposes of section 83(a) and sect1.83-1(b)(1), therefore, A has disposed of the 40 shares of substantially-nonvested stock on June 1, 2005, and must include in gross income as compensation 800 (the difference between the amount realized upon such disposition, 1,000, and the amount paid for the stock, 200). Accordingly, 40 shares of the incentive stock option stock have a 1,000 basis (the 200 original basis plus the 800 included in income as compensation) and 60 shares of the incentive stock option stock have a zero basis. For its taxable year in which the disposition of the substantially-nonvested stock occurs, X Corporation is allowed a deduction of 800 for the compensation paid to A, provided the requirements of section 83(h) and sect1.83-6(a) are satisfied and the deduction is otherwise allowable under section 162. (f) Effective date 8212 (1) In general . These regulations are effective on August 3, 2004. (2) Reliance and transition period . For statutory options granted on or before June 9, 2003, taxpayers may rely on the 1984 proposed regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-122917-02 (68 FR 34344), or this section until the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring 6 months after August 3, 2004. For statutory options granted after June 9, 2003, and before the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after August 3, 2004, taxpayers may rely on either the REG-122917-02 or this section. Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 2005. Reliance on LR-279-81, REG-122917-02, or this section must be in its entirety, and all statutory options granted during the reliance period must be treated consistently. sect1.423-1 Amended 14. Revising paragraph (d). 15. Revising paragraphs (e)(1) and (e)(2). 16. In paragraph (e)(3), first sentence, remove the phrase 8220Except as otherwise provided in subparagraph (4) of this paragraph8221 and add 8220If section 423(c) applies to an option then,8221. 17. In paragraph (e)(3), first sentence, remove the language 8220, and 424(b)(1).8221 18. Removing paragraph (e)(4). 19. Redesignating paragraph (e)(5) as paragraph (e)(4). 20. Revising newly designated paragraph (e)(4). 21. Redesignating paragraph (e)(6) as paragraph (e)(5) and removing the second and third sentences. 22. Adding and reserving a new paragraph (e)(6). 23. In list below, for each section indicated in the left column, remove the language in the middle column and add the language in the right column: sect 1.424-1 Definitions and special rules applicable to statutory options. (a) Substitutions and assumptions of options 8212(1) In general . (i) This paragraph (a) provides rules under which an eligible corporation (as defined in paragraph (a)(2) of this section) may, by reason of a corporate transaction (as defined in paragraph (a)(3) of this section), substitute a new statutory option (new option) for an outstanding statutory option (old option) or assume an old option without such substitution or assumption being considered a modification of the old option. For the definition of modification . see paragraph (e) of this section. (ii) For purposes of sectsect1.421-1 through 1.424-1, the phrase 8220substituting or assuming a stock option in a transaction to which section 424 applies,8221 8220substituting or assuming a stock option in a transaction to which sect1.424-1(a) applies,8221 and similar phrases means a substitution of a new option for an old option or an assumption of an old option that meets the requirements of this paragraph (a). For a substitution or assumption to qualify under this paragraph (a), the substitution or assumption must meet all of the requirements described in paragraphs (a)(4) and (a)(5) of this section. (2) Eligible corporation . For purposes of this paragraph (a), the term eligible corporation means a corporation that is the employer of the optionee or a related corporation of such corporation. For purposes of this paragraph (a), the determination of whether a corporation is the employer of the optionee or a related corporation of such corporation is based upon all of the relevant facts and circumstances existing immediately after the corporate transaction. See sect1.421-1(h) for rules concerning the employment relationship. (3) Corporate transaction . For purposes of this paragraph (a), the term corporate transaction includes8212 (i) A corporate merger, consolidation, acquisition of property or stock, separation, reorganization, or liquidation (ii) A distribution (excluding an ordinary dividend or a stock split or stock dividend described in sect1.424-1(e)(4)(v)) or change in the terms or number of outstanding shares of such corporation and (iii) Such other corporate events prescribed by the Commissioner in published guidance. (4) By reason of . (i) For a change in an option or issuance of a new option to qualify as a substitution or assumption under this paragraph (a), the change must be made by an eligible corporation (as defined in paragraph (a)(2) of this section) and occur by reason of a corporate transaction (as defined in paragraph (a)(3) of this section). (ii) Generally, a change in an option or issuance of a new option is considered to be by reason of a corporate transaction, unless the relevant facts and circumstances demonstrate that such change or issuance is made for reasons unrelated to such corporate transaction. For example, a change in an option or issuance of a new option will be considered to be made for reasons unrelated to a corporate transaction if there is an unreasonable delay between the corporate transaction and such change in the option or issuance of a new option, or if the corporate transaction serves no substantial corporate business purpose independent of the change in options. Similarly, a change in the number or price of shares purchasable under an option merely to reflect market fluctuations in the price of the stock purchasable under an option is not by reason of a corporate transaction. (iii) A change in an option or issuance of a new option is by reason of a distribution or change in the terms or number of the outstanding shares of a corporation (as described in paragraph (a)(3)(ii) of this section) only if the option as changed, or the new option issued, is an option on the same stock as under the old option (or if such class of stock is eliminated in the change in capital structure, on other stock of the same corporation). (5) Other requirements . For a change in an option or issuance of a new option to qualify as a substitution or assumption under this paragraph (a), all of the requirements described in this paragraph (a)(5) must be met. (i) In the case of an issuance of a new option (or a portion thereof) in exchange for an old option (or portion thereof), the optionee8217s rights under the old option (or portion thereof) must be canceled, and the optionee must lose all rights under the old option (or portion thereof). There cannot be a substitution of a new option for an old option within the meaning of this paragraph (a) if the optionee may exercise both the old option and the new option. It is not necessary to have a complete substitution of a new option for the old option. However, any portion of such option which is not substituted or assumed in a transaction to which this paragraph (a) applies is an outstanding option to purchase stock or, to the extent paragraph (e) of this section applies, a modified option. (ii) The excess of the aggregate fair market value of the shares subject to the new or assumed option immediately after the change in the option or issuance of a new option over the aggregate option price of such shares must not exceed the excess of the aggregate fair market value of all shares subject to the old option (or portion thereof) immediately before the change in the option or issuance of a new option over the aggregate option price of such shares. (iii) On a share by share comparison, the ratio of the option price to the fair market value of the shares subject to the option immediately after the change in the option or issuance of a new option must not be more favorable to the optionee than the ratio of the option price to the fair market value of the stock subject to the old option (or portion thereof) immediately before the change in the option or issuance of a new option. The number of shares subject to the new or assumed option may be adjusted to compensate for any change in the aggregate spread between the aggregate option price and the aggregate fair market value of the shares subject to the option immediately after the change in the option or issuance of the new option as compared to the aggregate spread between the option price and the aggregate fair market value of the shares subject to the option immediately before the change in the option or issuance of the new option. (iv) The new or assumed option must contain all terms of the old option, except to the extent such terms are rendered inoperative by reason of the corporate transaction. (v) The new option or assumed option must not give the optionee additional benefits that the optionee did not have under the old option. (6) Obligation to substitute or assume not necessary . For a change in the option or issuance of a new option to meet the requirements of this paragraph (a), it is not necessary to show that the corporation changing an option or issuing a new option is under any obligation to do so. In fact, this paragraph (a) may apply even when the option that is being replaced or assumed expressly provides that it will terminate upon the occurrence of certain corporate transactions. However, this paragraph (a) cannot be applied to revive a statutory option which, for reasons not related to the corporate transaction, expires before it can properly be replaced or assumed under this paragraph (a). (7) Issuance of stock without meeting the requirements of this paragraph (a) . A change in the terms of an option resulting in a modification of such option occurs if an optionee8217s new employer (or a related corporation of the new employer) issues its stock (or stock of a related corporation) upon exercise of such option without satisfying all of the requirements described in paragraphs (a)(4) and (5) of this section. (8) Date of grant . For purposes of applying the rules of this paragraph (a), a substitution or assumption is considered to occur on the date that the optionee would, but for this paragraph (a), be considered to have been granted the option that the eligible corporation is substituting or assuming. A substitution or an assumption that occurs by reason of a corporate transaction may occur before or after the corporate transaction. (10) Examples . The principles of this paragraph (a) are illustrated by the following examples: Example 1 . Eligible corporation . X Corporation acquires a new subsidiary, Y Corporation, and transfers some of its employees to Y. Y Corporation wishes to grant to its new employees and to the employees of X Corporation new options for Y shares in exchange for old options for X shares that were previously granted by X Corporation. Because Y Corporation is an employer with respect to its own employees and a related corporation of X Corporation, Y Corporation is an eligible corporation under paragraph (a)(2) of this section with respect to both the employees of X and Y Corporations. Przykład 2. Corporate transaction . (i) On January 1, 2004, Z Corporation grants E, an employee of Z, an option to acquire 100 shares of Z common stock. At the time of grant, the fair market value of Z common stock is 200 per share. E8217s option price is 200 per share. On July 1, 2005, when the fair market value of Z common stock is 400, Z declares a stock dividend of preferred stock distributed on common stock that causes the fair market value of Z common stock to decrease to 200 per share. On the same day, Z grants to E a new option to acquire 200 shares of Z common stock in exchange for E8217s old option. The new option has an exercise price of 100 per share. (ii) A stock dividend other than that described in sect1.424-1(e)(4)(v) is a corporate transaction under paragraph (a)(3)(ii) of this section. Generally, the issuance of a new option is considered to be by reason of a corporate transaction. None of the facts in this Example 2 indicate that the new option is not issued by reason of the stock dividend. In addition, the new option is issued on the same stock as the old option. Thus, the substitution occurs by reason of the corporate transaction. Assuming the other requirements of this section are met, the issuance of the new option is a substitution that meets the requirements of this paragraph (a) and is not a modification of the option. (iii) Assume the same facts as in paragraph (i) of this Example 2 . Assume further that on December 1, 2005, Z declares an ordinary cash dividend. On the same day, Z grants E a new option to acquire Z stock in substitution for E8217s old option. Under paragraph (a)(3)(ii) of this section, an ordinary cash dividend is not a corporate transaction. Thus, the exchange of the new option for the old option does not meet the requirements of this paragraph (a) and is a modification of the option. Example 3 . Corporate transaction . On March 15, 2004, A Corporation grants E, an employee of A, an option to acquire 100 shares of A stock at 50 per share, the fair market value of A stock on the date of grant. On May 2, 2005, A Corporation transfers several employees, including E, to B Corporation, a related corporation. B Corporation arranges to purchase some assets from A on the same day as E8217s transfer to B. Such purchase is without a substantial business purpose independent of making the exchange of E8217s old options for the new options appear to be by reason of a corporate transaction. The following day, B Corporation grants to E, one of its new employees, an option to acquire shares of B stock in exchange for the old option held by E to acquire A stock. Under paragraph (a)(3)(i) of this section, the purchase of assets is a corporate transaction. Generally, the substitution of an option is considered to occur by reason of a corporate transaction. However, in this case, the relevant facts and circumstances demonstrate that the issuance of the new option in exchange for the old option occurred by reason of the change in E8217s employer rather than a corporate transaction and that the sale of assets is without a substantial corporate business purpose independent of the change in the options. Thus, the exchange of the new option for the old option is not by reason of a corporate transaction that meets the requirements of this paragraph (a) and is a modification of the old option. Example 4 . Corporate transaction . (i) E, an employee of Corporation A, holds an option to acquire 100 shares of Corporation A stock. On September 1, 2006, Corporation A has one class of stock outstanding and declares a stock dividend of one share of common stock for each outstanding share of common stock. The rights associated with the common stock issued as a dividend are the same as the rights under existing shares of stock. In connection with the stock dividend, E8217s option is exchanged for an option to acquire 200 shares of Corporation A stock. The per-share exercise price is equal to one half of the per-share exercise price of the original option. The stock dividend merely changes the number of shares of Corporation A outstanding and effects no other change to the stock of Corporation A. The option is proportionally adjusted and the aggregate exercise price remains the same and therefore satisfies the requirements described in sect1.424-1(e)(4)(v). (ii) The stock dividend is not a corporate transaction under paragraph (a)(3) of this section, and the declaration of the stock dividend is not a modification of the old option under paragraph (a) of this section. Pursuant to sect1.424-1(e)(4)(v), the exercise price of the old option may be adjusted proportionally with the change in the number of outstanding shares of Corporation A such that the ratio of the aggregate exercise price of the option to the number of shares covered by the option is the same both before and after the stock dividend. The adjustment of E8217s option is not treated as a modification of the option. Example 5 . Additional benefit . On June 1, 2004, P Corporation acquires 100 percent of the shares of S Corporation and issues a new option to purchase P shares in exchange for an old option to purchase S shares that is held by E, an employee of S. On the date of the exchange, E8217s old option is exercisable for 3 more years, and, after the exchange, E8217s new option is exercisable for 5 years. Because the new option is exercisable for an additional period of time beyond the time allowed under the old option, the effect of the exchange of the new option for the old option is to give E an additional benefit that E did not enjoy under the old option. Thus, the requirements of paragraph (a)(5) of this section are not met, and this paragraph (a) does not apply to the exchange of the new option for the old option. Therefore, the exchange is a modification of the old options. Example 6 . Spread and ratio tests . E is an employee of S Corporation. E holds an old option that was granted to E by S to purchase 60 shares of S at 12 per share. On June 1, 2005, S Corporation is merged into P Corporation, and on such date P issues a new option to purchase P shares in exchange for E8217s old option to purchase S shares. Immediately before the exchange, the fair market value of an S share is 32 immediately after the exchange, the fair market value of a P share is 24.The new option entitles E to buy P shares at 9 per share. Because, on a share-by-share comparison, the ratio of the new option price (9 per share) to the fair market value of a P share immediately after the exchange (24 per share) is not more favorable to E than the ratio of the old option price (12 per share) to the fair market value of an S share immediately before the exchange (32 per share) (924 1232), the requirements of paragraph (a)(5)(iii) of this section are met. The number of shares subject to E8217s option to purchase P stock is set at 80.Because the excess of the aggregate fair market value over the aggregate option price of the shares subject to E8217s new option to purchase P stock, 1,200 (80 x 24 minus 80 x 9), is not greater than the excess of the aggregate fair market value over the aggregate option price of the shares subject to E8217s old option to purchase S stock, 1,200 (60 x 32 minus 60 x 12), the requirements of paragraph (a)(5)(ii) of this section are met. Example 7 . Ratio test and partial substitution . Assume the same facts as in Example 6 . except that the fair market value of an S share immediately before the exchange of the new option for the old option is 8, that the option price is 10 per share, and that the fair market value of a P share immediately after the exchange is 12.P sets the new option price at 15 per share. Because, on a share-by-share comparison, the ratio of the new option price (15 per share) to the fair market value of a P share immediately after the exchange (12) is not more favorable to E than the ratio of the old option price (10 per share) to the fair market value of an S share immediately before the substitution (8 per share) (1512 108), the requirements of paragraph (a)(5)(iii) of this section are met. Assume further that the number of shares subject to E8217s P option is set at 20, as compared to 60 shares under E8217s old option to buy S stock. Immediately after the exchange, 2 shares of P are worth 24, which is what 3 shares of S were worth immediately before the exchange (2 x 12 3 x 8).Thus, to achieve a complete substitution of a new option for E8217s old option, E would need to receive a new option to purchase 40 shares of P ( i. e. . 2 shares of P for each 3 shares of S that E could have purchased under the old option (23 4060)). Because E8217s new option is for only 20 shares of P, P has replaced only 1 2 of E8217s old option, and the other 1 2 is still outstanding. Example 8 . Partial substitution . X Corporation forms a new corporation, Y Corporation, by a transfer of certain assets and, in a spin-off, distributes the shares of Y Corporation to the stockholders of X Corporation. E, an employee of X Corporation, is thereafter an employee of Y. Y wishes to substitute a new option to purchase some of its stock for E8217s old option to purchase 100 shares of X. E8217s old option to purchase shares of X, at 50 a share, was granted when the fair market value of an X share was 50, and an X share was worth 100 just before the distribution of the Y shares to X8217s stockholders. Immediately after the spin-off, which is also the time of the substitution, each share of X and each share of Y is worth 50.Based on these facts, a new option to purchase 200 shares of Y at an option price of 25 per share could be granted to E in complete substitution of E8217s old option. In the alternative, it would also be permissible in connection with a spinoff to grant E a new option to purchase 100 shares of Y, at an option price of 25 per share, and for E to retain an option to purchase 100 shares of X under the old option, with the option price adjusted to 25. However, because X is no longer a related corporation with respect to Y, E must exercise the option for 100 shares of X within three months from the date of the spinoff for the option to be treated as a statutory option. See sect1.421-1(h). Example 9 . Stockholder approval requirements . (i) X Corporation, a publicly traded corporation, adopts an incentive stock option plan that meets the requirements of sect1.422-2. Under the plan, options to acquire X stock are granted to X employees. X Corporation is acquired by Y Corporation and becomes a subsidiary corporation of Y Corporation. After the acquisition, X employees remain employees of X. In connection with the acquisition, Y Corporation substitutes new options to acquire Y stock for the old options to acquire X stock previously granted to the employees of X. As a result of this substitution, on exercise of the new options, X employees receive Y Corporation stock. (ii) Because the requirements of sect1.422-2 were met on the date of grant, the substitution of the new Y options for the old X options does not require new stockholder approval. If the other requirements of paragraphs (a)(4) and (5) of this section are met, the issuance of new options for Y stock in exchange for the old options for X stock meets the requirements of this paragraph (a) and is not a modification of the old options. (iii) Assume the same facts as in paragraphs (i) and (ii) of this Example 9 . Assume further that as part of the acquisition, X amends its plan to allow future grants under the plan to be grants to acquire Y stock. Because the amendment of the plan to allow options on a different stock is considered the adoption of a new plan under sect1.422-2(b)(2)(iii), the stockholders of Y must approve the plan within 12 months before or after the date of the amendment of the plan. If the stockholders of Y timely approve the plan, the future grants to acquire Y stock will be incentive stock options (assuming the other requirements of sect1.422-2 have been met). Example 10 . Modification . X Corporation merges into Y Corporation. Y Corporation retains employees of X who hold old options to acquire X Corporation stock. When the former employees of X exercise the old options, Y Corporation issues Y stock to the former employees of X. Under paragraph (a)(7) of this section, because Y issues its stock on exercise of the old options for X stock, there is a change in the terms of the old options for X stock. Thus, the issuance of Y stock on exercise of the old options is a modification of the old options. Example 11 . Eligible corporation . (i) D Corporation grants an option to acquire 100 shares of D Corporation stock to E, an employee of D Corporation. S Corporation is a subsidiary of D Corporation. On March 1, 2005, D Corporation spins off S Corporation. E remains an employee of D Corporation. In connection with the spin off, D Corporation substitutes a new option to acquire D Corporation stock and a new option to acquire S Corporation stock for the old option in a manner that meets the requirements of paragraph (a) of this section. (ii) The substitution of the new option to acquire S and D stock for the old option to acquire D stock is not a modification of the old option. However, because S is no longer a related corporation with respect to D Corporation, E must exercise the option for S stock within three months from March 1, 2005, for the option to be treated as a statutory option. See sect1.421-1(h). (iii) Assume the same facts as in paragraph (i) of this Example 11 except that E8217s employment with D Corporation is terminated on February 20, 2005. The substitution of the new option to acquire S and D stock for the old option to acquire D stock is not a modification of the old option. However, because the employment relationship between E and D Corporation terminated on February 20, 2005, E must exercise the option for the D and S stock within three months from February 20, 2005, for the option to be treated as a statutory option. See sect1.421-1(h). (iv) A transfer between spouses or incident to divorce (described in section 1041(a)). The special tax treatment of sect1.421-2(a) with respect to the transferred stock applies to the transferee. However, see sect1.421-1(b)(2) for the treatment of the transfer of a statutory option incident to divorce. (3) If an optionee exercises an incentive stock option with statutory option stock and the applicable holding period requirements (under sect1.422-1(a) or sect1.423-1(a)) with respect to such statutory option stock are not met before such transfer, then sections 354, 355, 356, or 1036 (or so much of 1031 as relates to 1036) do not apply to determine whether there is a disposition of those shares. Therefore, there is a disposition of the statutory option stock, and the special tax treatment of sect 1.421-2(a) does not apply to such stock. Example 7 . On January 1, 2004, X Corporation grants to E, an employee of X Corporation, an incentive stock option to purchase 100 shares of X Corporation stock at 100 per share (the fair market value of an X Corporation share on that date). On January 1, 2005, when the fair market value of a share of X Corporation stock is 200, E exercises half of the option, pays X Corporation 5,000 in cash, and is transferred 50 shares of X Corporation stock with an aggregate fair market value of 10,000. E makes no disposition of the shares before January 2, 2006. Under sect1.421-2(a), no income is recognized by E on the transfer of shares pursuant to the exercise of the incentive stock option, and X Corporation is not entitled to any deduction at any time with respect to its transfer of the shares to E. E8217s basis in the shares is 5,000. Example 8 . Assume the same facts as in Example 7 . except that on December 1, 2005, one year and 11 months after the grant of the option and 11 months after the transfer of the 50 shares to E, E uses 25 of those shares, with a fair market value of 5,000, to pay for the remaining 50 shares purchasable under the option. On that day, X Corporation transfers 50 of its shares, with an aggregate fair market value of 10,000, to E. Because E disposed of the 25 shares before the expiration of the applicable holding periods, sect1.421-2(a) does not apply to the January 1, 2005, transfer of the 25 shares used by E to exercise the remainder of the option. As a result of the disqualifying disposition of the 25 shares, E recognizes compensation income under the rules of sect1.421-2(b). Example 9 . On January 1, 2005, X Corporation grants an incentive stock option to E, an employee of X Corporation. The exercise price of the option is 10 per share. On June 1, 2005, when the fair market value of an X Corporation share is 20, E exercises the option and purchases 5 shares with an aggregate fair market value of 100. On January 1, 2006, when the fair market value of an X Corporation share is 50, X Corporation is acquired by Y Corporation in a section 368(a)(1)(A) reorganization. As part of the acquisition, all X Corporation shares are converted into Y Corporation shares. After the conversion, if an optionee holds a fractional share of Y Corporation stock, Y Corporation will purchase the fractional share for cash equal to its fair market value. After applying the conversion formula to the shares held by E, E has 10 1 2 Y Corporation shares. Y Corporation purchases E8217s one-half share for 25, the fair market value of one-half of a Y Corporation share on the conversion date. Because E sells the one-half share prior to expiration of the holding periods described in sect1.422-1(a), the sale is a disqualifying disposition of the one-half share. Thus, in 2006, E must recognize compensation income of 5 (one-half of the fair market value of an X Corporation share on the date of exercise of the option, or 10, less one-half of the exercise price per share, or 5). For purposes of computing any additional gain, E8217s basis in the one-half share increases to 10 (reflecting the 5 included in income as compensation). E recognizes an additional gain of 15 (25, the fair market value of the one-half share, less 10, the basis in such share). The extent to which the additional 15 of gain is treated as a redemption of Y Corporation stock is determined under section 302. (d) Attribution of stock ownership . To determine the amount of stock owned by an individual for purposes of applying the percentage limitations relating to certain stockholders described in sectsect1.422-2(f) and 1.423-2(d), shares of the employer corporation or of a related corporation that are owned (directly or indirectly) by or for the individual8217s brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants, are considered to be owned by the individual. Also, for such purposes, if a domestic or foreign corporation, partnership, estate, or trust owns (directly or indirectly) shares of the employer corporation or of a related corporation, the shares are considered to be owned proportionately by or for the stockholders, partners, or beneficiaries of the corporation, partnership, estate, or trust. The extent to which stock held by the optionee as a trustee of a voting trust is considered owned by the optionee is determined under all of the facts and circumstances. (e) Modification, extension, or renewal of option . (1) This paragraph (e) provides rules for determining whether a share of stock transferred to an individual upon the individual8217s exercise of an option after the terms of the option have been changed is transferred pursuant to the exercise of a statutory option. (2) Any modification, extension, or renewal of the terms of an option to purchase shares is considered the granting of a new option. The new option may or may not be a statutory option. To determine the date of grant of the new option for purposes of section 422 or 423, see sect1.421-1(c). (4)(i) For purposes of sectsect1.421-1 through 1.424-1 the term modification means any change in the terms of the option (or change in the terms of the plan pursuant to which the option was granted or in the terms of any other agreement governing the arrangement) that gives the optionee additional benefits under the option regardless of whether the optionee in fact benefits from the change in terms. In contrast, for example, a change in the terms of the option shortening the period during which the option is exercisable is not a modification. However, a change providing an extension of the period during which an option may be exercised (such as after termination of employment) or a change providing an alternative to the exercise of the option (such as a stock appreciation right) is a modification regardless of whether the optionee in fact benefits from such extension or alternative right. Similarly, a change providing an additional benefit upon exercise of the option (such as the payment of a cash bonus) or a change providing more favorable terms for payment for the stock purchased under the option (such as the right to tender previously acquired stock) is a modification. (ii) If an option is not immediately exercisable in full, a change in the terms of the option to accelerate the time at which the option (or any portion thereof) may be exercised is not a modification for purposes of this section. Additionally, no modification occurs if a provision accelerating the time when an option may first be exercised is removed prior to the year in which it would otherwise be triggered. For example, if an acceleration provision is timely removed to avoid exceeding the 100,000 limitation described in sect1.422-4, a modification of the option does not occur. (iii) A change to an option which provides, either by its terms or in substance, that the optionee may receive an additional benefit under the option at the future discretion of the grantor, is a modification at the time that the option is changed to provide such discretion. In addition, the exercise of discretion to provide an additional benefit is a modification of the option. However, it is not a modification for the grantor to exercise discretion specifically reserved under an option with respect to the payment of a cash bonus at the time of exercise, the availability of a loan at exercise, the right to tender previously acquired stock for the stock purchasable under the option, or the payment of employment taxes andor required withholding taxes resulting from the exercise of a statutory option. An option is not modified merely because an optionee is offered a change in the terms of an option if the change to the option is not made. An offer to change the terms of an option that remains open less than 30 days is not a modification of the option. However, if an offer to change the terms of an option remains outstanding for 30 days or more, there is a modification of the option as of the date the offer to change the option is made. (iv) A change in the terms of the stock purchasable under the option that increases the value of the stock is a modification of such option, except to the extent that a new option is substituted for such option by reason of the change in the terms of the stock in accordance with paragraph (a) of this section. (v) If an option is amended solely to increase the number of shares subject to the option, the increase is not considered a modification of the option but is treated as the grant of a new option for the additional shares. Notwithstanding the previous sentence, if the exercise price and number of shares subject to an option are proportionally adjusted to reflect a stock split (including a reverse stock split) or stock dividend, and the only effect of the stock split or stock dividend is to increase (or decrease) on a pro rata basis the number of shares owned by each shareholder of the class of stock subject to the option, then the option is not modified if it is proportionally adjusted to reflect the stock split or stock dividend and the aggregate exercise price of the option is not less than the aggregate exercise price before the stock split or stock dividend. (vi) Any change in the terms of an option made in an attempt to qualify the option as a statutory option grants additional benefits to the optionee and is, therefore, a modification. (vii) An extension of an option refers to the granting by the corporation to the optionee of an additional period of time within which to exercise the option beyond the time originally prescribed. A renewal of an option is the granting by the corporation of the same rights or privileges contained in the original option on the same terms and conditions. The rules of this paragraph apply as well to successive modifications, extensions, and renewals. (viii) Any inadvertent change to the terms of an option (or change in the terms of the plan pursuant to which the option was granted or in the terms of any other agreement governing the arrangement) that is treated as a modification under this paragraph (e) is not considered a modification of the option to the extent the change in the terms of the option is removed by the earlier of the date the option is exercised or the last day of the calendar year during which such change occurred. Thus, for example, if the terms of an option are inadvertently changed on March 1 to extend the exercise period and the change is removed on November 1, then if the option is not exercised prior to November 1, the option is not considered modified under this paragraph (e). (f) Definitions . The following definitions apply for purposes of sectsect1.421-1 through 1.424-1: (1) Parent corporation . The term parent corporation . or parent . means any corporation (other than the employer corporation) in an unbroken chain of corporations ending with the employer corporation if, at the time of the granting of the option, each of the corporations other than the employer corporation owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. (2) Subsidiary corporation . The term subsidiary corporation . or subsidiary . means any corporation (other than the employer corporation) in an unbroken chain of corporations beginning with the employer corporation if, at the time of the granting of the option, each of the corporations other than the last corporation in an unbroken chain owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. (g) Effective date 8212 (1) In general . These regulations are effective on August 3, 2004. (2) Reliance and transition period . For statutory options granted on or before June 9, 2003, taxpayers may rely on the 1984 proposed regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-122917-02 (68 FR 34344), or this section until the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring 6 months after August 3, 2004. For statutory options granted after June 9, 2003, and before the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after August 3, 2004, taxpayers may rely on either the REG-122917-02 or this section. Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 2005. Reliance on LR-279-81, REG-122917-02, or this section must be in its entirety, and all statutory options granted during the reliance period must be treated consistently. sect1.6039-1 and 1.6039-2 Removed