[Federal Register Volume 74, Number 220 (Tuesday, November 17, 2009)]
[Rules and Regulations]
[Pages 59074-59087]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-27452]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9471]
RIN 1545-BH68
Employee Stock Purchase Plans Under Internal Revenue Code Section
423
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains the final regulations relating to
options granted under an employee stock purchase plan as defined in
section 423 of the Internal Revenue Code (Code). These final
regulations affect certain taxpayers who participate in the transfer of
stock pursuant to the exercise of options granted under an employee
stock purchase plan. These final regulations provide guidance to assist
taxpayers in complying with section 423 in addition to clarifying
certain rules regarding options granted under an employee stock
purchase plan. This document also contains final regulations under
sections 421, 422 and 424 of the Code.
DATES: Effective Date: These regulations are effective on November 17,
2009.
Applicability Date: These regulations apply as of January 1, 2010.
FOR FURTHER INFORMATION CONTACT: Thomas Scholz or Ilya Enkishev at
(202) 622-6030 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final amendments to the Income Tax
Regulations (26 CFR part 1) under sections 421, 422, 423 and 424 of the
Code.
Section 423 was added to the Code by section 221(a) of the Revenue
Act of 1964, Public Law 88-272 (78 Stat. 63 (1964)). Changes to the
applicable law concerning section 423 were made by sections
1402(b)(1)(C) and 1402(b)(2) of the Tax Reform Act of 1976, Public Law
94-455 (90 Stat. 1731 and 1732-1733 (1976)); section 1001(b)(5) of the
Deficit Reduction Act of 1984, Public Law 98-369 (98 Stat. 1011
(1984)); section 1114 of the Tax Reform Act of 1986, Public Law 99-514
(100 Stat. 2451 (1986)); and sections 11801(c)(9)(D)(i), (ii) and
11801(c)(9)(E) of the Omnibus Budget Reconciliation Act of 1990, Public
Law 101-508 (104 Stat. 1388-525 (1990)).
Regulations under section 423 were published in the Federal
Register on June 23, 1966 (TD 6887). These
[[Page 59075]]
regulations were amended on September 27, 1979 (TD 7645), October 31,
1980 (TD 7728), and December 1, 1988 (TD 8235). In Notice 2004-55
(2004-34 IRB 319 (August 23, 2004)) (see Sec. 601.601(d)(2)(ii)(b)),
the IRS and the Treasury Department requested comments concerning
whether the existing regulations under section 423 should be amended,
and if so, what issues should be addressed.
On July 29, 2008, the Treasury Department published a notice of
proposed rulemaking (REG-106251-08) in the Federal Register (73 FR
43875) under section 423. A public hearing on the proposed regulations
was held on January 15, 2009. Written and electronic comments
responding to the notice of proposed rulemaking were received. After
consideration of these comments, the Treasury Department adopts the
proposed regulations as final regulations, with the modifications set
forth in this Treasury decision. The significant revisions are
discussed in this preamble.
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 the option is
determined under section 83 and the regulations thereunder. However,
section 421 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 sections 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 the
transfer and no deduction under section 162 is allowed to the employer
corporation with respect to the transfer.
Section 423(a) provides that section 421 applies to the transfer of
stock to an individual pursuant to the exercise of an option granted
under an employee stock purchase plan if: (i) No disposition of the
stock is made within two years from the date of grant of the option or
within one 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 three 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 423(b) sets
forth several requirements that must be met for a plan to qualify as an
employee stock purchase plan. Section 423(c) provides a special rule
that is applicable where the option exercise price is between 85 and
100 percent of the fair market value of the stock at the time the
option was granted.
Explanation of Provisions
These final regulations provide a comprehensive set of rules
governing stock options issued under an employee stock purchase plan
and incorporate substantially all of the rules contained in the
existing regulations under section 423. These final regulations are
comprised of two sections: Section 1.423-1, applicability of section
421(a); and Sec. 1.423-2, employee stock purchase plan defined. The
modifications to the proposed regulations that are included in these
final regulations reflect consideration of the comments submitted by
taxpayers.
1. General Requirements
The proposed regulations provide that an employee stock purchase
plan must meet the requirements of paragraphs (i) through (ix) of Sec.
1.423-2(a)(2) to qualify as an employee stock purchase plan under
section 423(b). The proposed regulations also provide that the
requirements of paragraphs (iii) through (ix) of Sec. 1.423-2(a)(2)
may be satisfied by the terms of the plan or an offering made under the
plan. The final regulations adopt these requirements of the proposed
regulations, although the numerical designation of the requirements is
modified. To emphasize that the requirements of paragraphs (iii)
through (ix) of Sec. 1.423-2(a)(2) of the proposed regulations may be
satisfied by the terms of the plan or an offering made under the plan,
these final regulations separately list these requirements in Sec.
1.423-2(a)(3).
Commenters requested clarification of whether options with terms
that are inconsistent with the terms of the plan will be eligible for
the special tax treatment of section 421. As provided in Sec. 1.423-
2(a)(3) of the proposed regulations, Sec. 1.423-2(a)(4) of these final
regulations provides that, if the terms of an option are inconsistent
with the terms of the employee stock purchase plan or an offering under
the plan, then the option will not be treated as granted under an
employee stock purchase plan. However, an option may still qualify for
the special tax treatment of section 421, even if the terms of the plan
are inconsistent with any of the requirements in Sec. 1.423-2(a)(3) of
these final regulations, if the option is granted under an offering
with terms that comply with the requirements of Sec. 1.423-2(a)(3).
Example 2 of Sec. 1.423-2(e)(6) of these final regulations illustrates
this principle.
2. Offerings Under an Employee Stock Purchase Plan
These final regulations provide further guidance for employee stock
purchase plans under which more than one offering is made. As set forth
in Sec. 1.423-2(a)(1) of these final regulations, one or more
offerings may be made under a plan and the offerings may be consecutive
or overlapping. Further, pursuant to section 423(b) and its flush
language, the terms of each offering need not be identical. Although
the terms of each offering need not be identical, the terms of the plan
and each offering together must satisfy the requirements of Sec.
1.423-2(a)(2) and (3) of these final regulations. For example, if
overlapping offerings are made under an employee stock purchase plan,
then each offering may contain different terms, provided that the terms
of each offering (together with the plan) satisfy the requirements of
Sec. 1.423-2(a)(3) of these final regulations. Furthermore, when a
parent corporation adopts an employee stock purchase plan, it may
establish separate offerings with different terms under the plan and
designate which subsidiary corporations of the parent corporation may
participate in a particular offering, provided that the terms of each
offering (together with the plan) satisfy the requirements of Sec.
1.423-2(a)(3). The terms ``parent corporation'' and ``subsidiary
corporation'' are defined in Sec. 1.424-1(f) of the regulations.
a. Employees Covered by the Plan
Paragraphs (i) through (iv) of Sec. 1.423-2(e)(1) of the proposed
regulations and these final regulations set forth the categories of
employees that may be excluded from coverage under an employee stock
purchase plan or an offering under the plan. The proposed regulations
provide that the exclusions for various categories of employees must be
applied in an identical manner to all employees of every corporation
whose employees are granted options under the plan. Commenters noted
that the requirement of identical exclusions for all offerings under a
plan constrains the ability to make future and overlapping offerings
that are more (or less) inclusive than prior offerings under the plan.
Commenters suggested that the final regulations should permit multiple
[[Page 59076]]
offerings under a plan with different exclusions applicable to the one
or more corporations whose employees participate in the particular
offering under the plan.
These final regulations generally adopt the approach suggested by
the commenters. Pursuant to these final regulations, whether the terms
of a plan and offering satisfy the requirements of Sec. 1.423-2(e) is
made on an offering-by-offering basis. The terms of each offering under
a plan may be different, provided the plan and offering together
satisfy the requirements of Sec. 1.423-2(a)(2) and (3) of these final
regulations. With respect to satisfying the requirements of Sec.
1.423-2(e), the terms of each offering may provide different exclusions
of employees, as permitted and within the limitations described in
Sec. 1.423-2(e)(1), (2) and (3) of these final regulations. The
exclusions established with respect to a particular offering must be
applied in an identical manner to all employees of every corporation
whose employees are granted options under that particular offering.
Examples 7 and 8 of Sec. 1.423-2(e)(6) of these final regulations
illustrate these principles.
Some commenters suggested that the final regulations permit
employers to exclude from plan participation employees who are
nonresident aliens and who receive no earned income that constitutes
income from sources within the United States. Other commenters
suggested that the final regulations permit employers to exclude from
plan participation employees under a specified age. The IRS and the
Treasury Department are aware of the complexities often associated with
participation in an employee stock purchase plan by nonresident aliens
and employees under a specified age, such as the age of majority.
However, section 423 does not provide exclusions for nonresident aliens
or employees under a specified age. Accordingly, the IRS and the
Treasury Department are constrained by statutory authority from
providing a general exclusion from plan participation for employees who
are nonresident aliens or employees under a specified age.
One commenter suggested that the final regulations provide
additional flexibility by permitting employers to exclude from plan
participation highly compensated employees (HCEs) (within the meaning
of section 414(q)) on any basis. Section 1.423-2(e)(2)(ii) of the
proposed regulations provides that the terms of an employee stock
purchase plan may exclude HCEs: (a) with compensation above a certain
level, or (b) who are officers or subject to the disclosure
requirements of section 16(a) of the Securities Exchange Act of 1934,
provided the exclusion is applied in an identical manner to all HCEs of
every corporation whose employees are granted options under the plan.
These final regulations do not adopt the suggestion that HCEs may be
excluded from participation in an employee stock purchase plan on any
basis. Instead, these final regulations offer some additional
flexibility by providing that, with respect to the exclusion of HCEs,
the terms of each offering made under a plan need not be identical with
respect to the HCEs, provided the HCEs are excluded as permitted and
within the limitations described in Sec. 1.423-2(e)(2)(ii) of these
final regulations.
b. Equal Rights and Privileges
Commenters further suggested that the final regulations provide
flexibility by permitting employers to make multiple offerings with
different rights and privileges applicable to the participants of each
offering under a plan. These final regulations generally adopt the
approach suggested by the commenters. Pursuant to these final
regulations, the determination of whether the terms of an offering
satisfy the requirements of Sec. 1.423-2(f) is made on an offering-by-
offering basis. The terms of each offering under a plan may be
different, provided the plan and offering together satisfy the
requirements of Sec. 1.423-2(a)(2) and (3) of these final regulations.
However, the rights and privileges established with respect to a
particular offering must be applied in an identical manner to all
employees of every corporation whose employees are granted options
under that particular offering. Examples 4 and 5 of Sec. 1.423-2(f)(7)
of these final regulations illustrate these principles.
3. Maximum Number of Shares That May Be Purchased By an Employee
Commenters asked whether the designation of a maximum number of
shares that may be purchased by an employee during the offering is
necessary in order for the first day of the offering period to be the
date of grant. Consistent with the proposed regulations, Sec. 1.423-
2(h)(3) of these final regulations provides that the date of grant will
be the first day of an offering period if the terms of an employee
stock purchase plan or offering designate a maximum number of shares
that may be purchased by each employee during the offering. Similarly,
the date of grant will be the first day of an offering if the terms of
the plan or offering require the application of a formula to establish,
on the first day of the offering, the maximum number of shares that may
be purchased by each employee during the offering.
However, Sec. 1.423-2(h)(3) of these final regulations does not
require that an employee stock purchase plan or offering designate a
maximum number of shares that may be purchased by each employee during
the offering or incorporate a formula to establish a maximum number of
shares that may be purchased by each employee during the offering. If
the maximum number of shares that can be purchased under an option is
not fixed or determinable until the date the option is exercised, then
the date of exercise will be the date of grant of the option. As
discussed in the preamble to the proposed regulations, the $25,000
limit under section 423(b)(8) and the limit on the aggregate number of
shares that may be issued under an employee stock purchase plan are not
sufficient to establish the maximum number of shares that can be
purchased by an employee under an option so that the date of grant will
be the first day of the offering. Examples 1, 2, 3 and 4 in Sec.
1.423-2(h)(4) of these final regulations illustrate these principles.
Commenters also asked whether any particular number of shares is
necessary to satisfy the requirement to designate a maximum number of
shares that may be purchased during the offering in order for the first
day of the offering period to be the date of grant. No particular
number of shares is necessary to satisfy this requirement and establish
the first day of the offering period as the date of grant for the
option. These final regulations adopt Sec. 1.423-2(h)(3) of the
proposed regulations to provide that the designation of any maximum
number of shares is sufficient to establish the first day of the
offering period as the date of grant for the option.
4. Annual $25,000 Limitation
Section 423(b)(8) provides that an employee stock purchase plan
must, by its terms, provide that no employee may be permitted to accrue
the right to purchase stock under all the employee stock purchase plans
of his or her employer corporation and its related corporations at a
rate which exceeds $25,000 in fair market value of the stock
(determined on the date of grant) for each calendar year in which an
option granted to the employee is outstanding. Section 423(b)(8)(A)
provides that the right to purchase stock under an option accrues when
the option first becomes exercisable.
In drafting the proposed regulations, the Treasury Department and
the IRS were aware that taxpayers were interpreting the $25,000
limitation
[[Page 59077]]
inconsistently. Certain taxpayers interpreted section 423(b)(8) to mean
that the limit increases by $25,000 for each calendar year during which
the option is outstanding and exercisable; other taxpayers interpreted
the sections to mean that such limit increases for each calendar year
during which the option is simply outstanding. Consistent with comments
received by the Treasury Department and the IRS in response to Notice
2004-55 (2004-34 IRB 319 (August 23, 2004)), (see Sec.
601.601(d)(2)(ii)(b)), the proposed regulations adopted an approach
that was generally consistent with the $100,000 limitation for
incentive stock options and interpreted section 423(b)(8) to mean that
the limit increases by $25,000 for each calendar year during which the
option is outstanding and exercisable.
In response to the proposed regulations, several commenters
suggested that the Treasury Department and the IRS reconsider the
calculation of the $25,000 limitation in section 423(b)(8). Commenters
suggested that the regulations adopt an approach that permits an option
to accrue at a rate of $25,000 for each calendar year that the option
is simply outstanding. Specifically, even though section 423(b)(8)(A)
provides that the right to purchase stock actually accrues when the
option first becomes exercisable during a calendar year, the first
sentence of section 423(b)(8) provides that the limit on accruals is
$25,000 ``for each year in which such option is outstanding.'' Upon
further consideration and in response to the foregoing comments, these
final regulations modify Sec. 1.423-2(i) of the proposed regulations
to provide that the limit increases by $25,000 for each calendar year
that an option is outstanding. Example 5 in Sec. 1.423-2(i)(5) of
these final regulations has been modified to illustrate this principle.
5. Stockholder Approval Requirements
To qualify as an employee stock purchase plan, section 423(b)(2)
requires that the plan be approved by the stockholders of the granting
corporation within 12 months before or after the date the plan is
adopted. These final regulations clarify that new stockholder approval
is required if there is a change in the shares with respect to which
options are issued or a change in the granting corporation. In
particular, these final regulations clarify that the stockholders of a
subsidiary corporation include the parent corporation and any other
stockholders of the subsidiary. Accordingly, these final regulations
adopt Example 1(iii) in Sec. 1.423-2(c)(5) and Example 1(iii) in Sec.
1.422-2(b)(6) of the proposed regulations.
One commenter to the proposed regulations suggested that a
conforming change be made to Example 9(iii) in Sec. 1.424-1(a)(10)
which addresses the substitution of options in the context of an
acquisition. Example 9(iii) in Sec. 1.424-1(a)(10), as previously set
forth in the regulations, requires the stockholders of an acquiring
company to approve an amendment of the option plan of an acquired
corporate subsidiary to issue parent stock instead of subsidiary stock.
The commenter proposed that the example be amended to require the
acquiring company (instead of its stockholders) to approve the
amendment of the option plan to issue parent stock instead of
subsidiary stock. This amendment is consistent with Example 1(iii) in
Sec. 1.423-2(c)(5) and Example 1(iii) in Sec. 1.422-2(b)(6) of these
final regulations. Accordingly, Example 9(iii) in Sec. 1.424-1(a)(10)
of these final regulations has been modified to reflect the adoption of
the commenter's suggestion.
Effective/Applicability Date
These regulations apply as of January 1, 2010, and will apply to
any statutory option granted on or after that date. Taxpayers may rely
on these final regulations for the treatment of any statutory option
granted prior to January 1, 2010.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations and because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal authors of these regulations are Thomas Scholz and
Ilya Enkishev, Office of the Division Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities). However, other personnel from the
IRS and the Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805.
0
Par. 2. Section 1.421-1, paragraphs (c)(1) and (j)(1) are revised to
read as follows:
Sec. 1.421-1 Meaning and use of certain terms.
* * * * *
(c) Time and date of granting option. (1) For purposes of this
section and Sec. Sec. 1.421-2 through 1.424-1, the language ``the date
of the granting of the option'' and ``the time such option is
granted,'' 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. Except as set forth in Sec. 1.423-2(h)(2), 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.
* * * * *
(j) Effective/applicability date--(1) In general. Except for
paragraph (c)(1) of this section, the regulations under this section
are effective on August 3, 2004. Paragraph (c)(1) of this section is
effective on November 17, 2009. Paragraph (c)(1) of this section
applies to statutory options granted on or after January 1, 2010.
* * * * *
0
Par. 3. Section 1.422-2, paragraph (b)(6), Example 1 (iii) is revised
to read as follows:
Sec. 1.422-2 Incentive stock options defined.
* * * * *
(b) * * *
(6) * * *
Example 1. * * *
(iii) Assume the same facts as in paragraph (i) of this Example
1, except that the plan was adopted on January 1, 2010. Assume
further that the plan was approved by the stockholders of S (in this
case, P) on March 1, 2010. On January 1, 2012, S changes the plan to
provide that incentive stock options for P stock will be granted to
S employees
[[Page 59078]]
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 stockholder of S (in this case, P)
within 12 months before or after January 1, 2012.
* * * * *
0
Par. 4. Section 1.422-5, paragraph (f)(1) is revised to read as
follows:
Sec. 1.422-5 Permissible provisions.
* * * * *
(f) Effective/applicability date--(1) In general. Except for Sec.
1.422-2(b)(6) Example 1 (iii), the regulations under this section are
effective on August 3, 2004. Section 1.422-2(b)(6) Example 1 (iii) is
effective on November 17, 2009. Section 1.422-2(b)(6) Example 1 (iii)
applies to statutory options granted on or after January 1, 2010.
* * * * *
0
Par. 5. Section 1.423-1 is revised to read as follows:
Sec. 1.423-1 Applicability of section 421(a).
(a) General rule. Subject to the provisions of section 423(c) and
Sec. 1.423-2(k), the special rules of income tax treatment provided in
section 421(a) apply with respect to the transfer of a share of stock
to an individual pursuant to the individual's exercise of an option
granted under an employee stock purchase plan, as defined in Sec.
1.423-2, if the following conditions are satisfied--
(1) The individual makes no disposition of such share before the
later of the expiration of the two-year period from the date of the
grant of the option pursuant to which such share was transferred or the
expiration of the one-year period from the date of transfer of such
share to the individual; and
(2) At all times during the period beginning on the date of the
grant of the option and ending on the day three months before the date
of exercise, the individual was an employee of the corporation granting
the option, a related corporation, or a corporation (or a related
corporation) substituting or assuming the stock option in a transaction
to which section 424(a) applies.
(b) Cross-references. For rules relating to the requisite
employment relationship, see Sec. 1.421-1(h). For rules relating to
the effect of a disqualifying disposition, see section 421(b) and Sec.
1.421-2(b). For the definition of the term ``disposition,'' see section
424(c) and Sec. 1.424-1(c). For the definition of the term ``related
corporation,'' see Sec. 1.421-1(i).
(c) Effective/applicability date. The regulations under this
section are effective on November 17, 2009. The regulations under this
section apply to options granted under an employee stock purchase plan
on or after January 1, 2010.
0
Par. 6. Section 1.423-2 is revised to read as follows:
Sec. 1.423-2 Employee stock purchase plan defined.
(a) In general--(1) The term ``employee stock purchase'' plan means
a plan that meets the requirements of paragraphs (a)(2) and (a)(3) of
this section. If the terms of the plan do not satisfy the requirements
of paragraph (a)(3) of this section, then such requirements may be
satisfied by the terms of an offering made under the plan. However,
where the requirements of paragraph (a)(3) of this section are
satisfied by the terms of an offering, such requirements will be
treated as satisfied only with respect to options exercised under that
offering. One or more offerings may be made under an employee stock
purchase plan. Offerings may be consecutive or overlapping, and the
terms of each offering need not be identical provided the terms of the
plan and the offering together satisfy the requirements of paragraphs
(a)(2) and (a)(3) of this section. The plan and the terms of an
offering must be in writing or electronic form, provided that such
writing or electronic form is adequate to establish the terms of the
plan or offering, as applicable.
(2) To satisfy the requirements of this paragraph (a)(2) and Sec.
1.423-1, the plan must meet both of the following requirements--
(i) The plan must provide that options can be granted only to
employees of the employer corporation or of a related corporation (as
defined in paragraph (i) of Sec. 1.421-1) to purchase stock in any
such corporation (see paragraph (b) of this section); and
(ii) The plan must be approved by the stockholders of the granting
corporation within 12 months before or after the date the plan is
adopted (see paragraph (c) of this section).
(3) To satisfy the requirements of this paragraph (a)(3) and Sec.
1.423-1, the terms of the plan or offering must meet all of the
following requirements--
(i) An employee cannot be granted an option if, immediately after
the option is granted, the employee owns stock possessing 5 percent or
more of the total combined voting power or value of all classes of
stock of the employer corporation or of a related corporation (see
paragraph (d) of this section);
(ii) Options must be granted to all employees of any corporation
whose employees are granted any options by reason of their employment
by the corporation (see paragraph (e) of this section);
(iii) All employees granted options must have the same rights and
privileges (see paragraph (f) of this section);
(iv) The option price cannot be less than the lesser of--
(A) An amount equal to 85 percent of the fair market value of the
stock at the time the option is granted, or
(B) An amount not less than 85 percent of the fair market value of
the stock at the time the option is exercised (see paragraph (g) of
this section).
(v) Options cannot be exercised after the expiration of--
(A) Five years from the date the option is granted if, under the
terms of such plan, the option price cannot be less than 85 percent of
the fair market value of the stock at the time the option is exercised,
or
(B) Twenty-seven months from the date the option is granted, if the
option price is not determined in the manner described in paragraph
(a)(3)(v)(A) of this section (see paragraph (h) of this section).
(vi) No employee may be granted an option that permits the
employee's rights to purchase stock under all employee stock purchase
plans of the employer corporation and its related corporations to
accrue at a rate that exceeds $25,000 of fair market value of the stock
(determined at the time the option is granted) for each calendar year
in which the option is outstanding at any time (see paragraph (i) of
this section); and
(vii) Options are not transferable by the optionee other than by
will or the laws of descent and distribution, and are exercisable,
during the lifetime of the optionee, only by the optionee (see
paragraph (j) of this section).
(4) The determination of whether a particular option is an option
granted under an employee stock purchase plan is made at the time the
option is granted. If the terms of an option are inconsistent with the
terms of the employee stock purchase plan or the offering under the
plan pursuant to which the option is granted, the option will not be
treated as granted under an employee stock purchase plan. If an option
with terms that are inconsistent with the terms of the plan or an
offering under the plan is granted to an employee who is entitled to
the grant of an option under the terms of the plan or offering, and the
employee is not granted an option under the offering that qualifies as
an option granted under an employee stock purchase plan, the
[[Page 59079]]
offering will not meet the requirements of paragraph (e) of this
section. Accordingly, none of the options granted under the offering
will be eligible for the special tax treatment of section 421. However,
if an option with terms that are inconsistent with the terms of the
plan or an offering under the plan is granted to an individual who is
not entitled to the grant of an option under the terms of the plan or
offering, the option will not be treated as an option granted under an
employee stock purchase plan but the grant of the option will not
disqualify the options granted under the plan or offering. If, at the
time of grant, an option qualifies as an option granted under an
employee stock purchase plan, but after the time of grant one or more
of the requirements of paragraph (a)(3) of this section is not
satisfied with respect to the option, the option will not be treated as
granted under an employee stock purchase plan but this failure to
comply with the terms of the option will not disqualify the other
options granted under the plan or offering.
(5) Examples. The following examples illustrate the principles of
paragraph (a):
Example 1. Corporation A operates an employee stock purchase
plan under which options for A stock are granted to employees of A.
The terms of an offering provide that the option price will be 90
percent of the fair market value of A stock on the date of exercise.
A grants an option under the offering to Employee Z, an employee of
A. The terms of the option provide that the option price will be 85
percent of the fair market value of A stock on the date of exercise.
Because the terms of Z's option are inconsistent with the terms of
the offering, the option granted to Z will not be treated as an
option granted under the employee stock purchase plan. Further,
unless Z is granted an option under the offering that qualifies as
an option granted under the employee stock purchase plan, the
offering will not meet the requirements of paragraph (e) of this
section and none of the options granted under the offering will be
eligible for the special tax treatment of section 421.
Example 2. Corporation B operates an employee stock purchase
plan that provides that options for B stock may only be granted to
employees of B. Under the terms of the plan, options may not be
granted to consultants and other non-employees. B grants an option
to Consultant Y, a consultant of B. Because Y is ineligible to
receive an option under the plan because Y is not an employee, the
grant of the option to Y is inconsistent with the terms of the plan
and the option granted to Y will not be treated as an option granted
under the employee stock purchase plan. However, the grant of the
option to Y will not disqualify the options granted under the plan
or any offering because Y was not entitled to the grant of an option
under the plan.
Example 3. Corporation C operates an employee stock purchase
plan under which options for C stock are granted to employees of C.
C grants an option pursuant to an offering under the plan to
Employee X, an employee of C who is a highly compensated employee.
The terms of the employee stock purchase plan exclude highly
compensated employees from participation in the plan. Because X is
ineligible to receive an option under the plan by reason of X's
exclusion from participation in the plan, the option granted to X
will not be treated as an option granted under the employee stock
purchase plan. However, the grant of the option to X will not
disqualify the options granted under the plan or offering because X
was not entitled to the grant of an option under the plan.
Example 4. Corporation D operates an employee stock purchase
plan under which options for D stock are granted to employees of D.
D grants an option pursuant to an offering under the plan to
Employee W, an employee of D. The terms of the option provide that
the option price will be 90 percent of the fair market value of D
stock on the date of exercise. On the date of exercise, W pays only
85 percent of the fair market value of D stock. Because the terms of
W's option are not satisfied, the option granted to W will not be
treated as an option granted under the employee stock purchase plan.
However, the failure to comply with the terms of the option granted
to W will not disqualify the options granted under the plan or
offering.
(b) Options restricted to employees. An employee stock purchase
plan must provide that options can be granted only to employees of the
employer corporation (or employees of its related corporations) to
purchase stock in the employer corporation (or one of its related
corporations). If such a provision is not included in the terms of the
plan, the plan will not be an employee stock purchase plan and options
granted under the plan will not qualify for the special tax treatment
of section 421. For rules relating to the employment requirement, see
Sec. 1.421-1(h).
(c) Stockholder approval--(1) An employee stock purchase plan must
be approved by the stockholders of the granting corporation within 12
months before or after the date such plan is adopted. The approval of
the stockholders must comply with all applicable provisions of the
corporate charter and bylaws and of applicable State law prescribing
the method and degree of stockholder approval required for the issuance
of corporate stock or options. If the applicable State law does not
prescribe a method and degree of stockholder approval, then an employee
stock purchase plan must be approved--
(i) By a majority of the votes cast at a duly held stockholder's
meeting at which a quorum representing a majority of all outstanding
voting stock is, either in person or by proxy, present and voting on
the plan; or
(ii) By a method and in a degree that would be treated as adequate
under applicable State law in the case of an action requiring
stockholder approval (such as, an action on which stockholders would be
entitled to vote if the action were taken at a duly held stockholders'
meeting).
(2) For purposes of the stockholder approval required by this
paragraph (c), ordinarily, a plan is adopted when it is approved by the
granting corporation's board of directors, and the date of the board's
action is the reference point for determining whether stockholder
approval occurs within the applicable 24-month period. However, if the
board's 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 board's resolution
fixes the date of adoption as the date of the board's action.
(3) An employee stock purchase plan, as adopted and approved, must
designate the maximum aggregate number of shares that may be issued
under the plan, and the corporations or class of corporations whose
employees may be offered options under the plan. A plan that merely
provides that the number of shares that may be issued under the plan
may not exceed a stated percentage of the shares outstanding at the
time of each offering or grant under the plan does not satisfy the
requirements of this paragraph (c)(3). 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
on 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 on the date of the adoption of the plan.
A plan that provides that the maximum aggregate number of shares that
may be issued as options under the plan may change based on any other
specific circumstances satisfies the requirements of this paragraph
only if the stockholders approve an immediately determinable maximum
number of shares that may be issued under the plan in any event. If
there is more than one employee stock purchase plan under which options
may be granted and stockholders of the granting corporation merely
approve a maximum aggregate number of shares that are
[[Page 59080]]
available for issuance under the plans, the stockholder approval
requirements described in paragraph (c)(1) of this section are not
satisfied. A separate maximum aggregate number of shares available for
issuance pursuant to options must be specified and approved for each
plan.
(4) Once an employee stock purchase plan is approved by the
stockholders of the granting corporation, the plan need not be
reapproved by the stockholders of the granting corporation unless the
plan is amended or changed in a manner that is considered the adoption
of a new plan, in which case the plan must be reapproved within the
prescribed 24-month period. Any increase in the 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) will be considered the adoption of a new
plan requiring stockholder approval within the prescribed 24-month
period. Similarly, a change in the designation of corporations whose
employees may be offered options under the plan will be considered the
adoption of a new plan requiring stockholder approval within the
prescribed 24-month period unless the plan provides that designations
of participating corporations may be made from time to time from among
a group consisting of the granting corporation and its related
corporations. The group from among which such changes and designations
are permitted without additional stockholder approval may include
corporations having become parents or subsidiaries of the granting
corporation after the adoption and approval of the plan. In addition, a
change in the granting corporation or the stock available for purchase
under the plan will be considered the adoption of a new plan requiring
stockholder approval within the prescribed 24-month period. Any other
changes in the terms of an employee stock purchase plan are not
considered the adoption of a new plan and, thus, do not require
stockholder approval.
(5) Examples. The following examples illustrate the principles of
this paragraph (c):
Example 1. (i) Corporation E is a subsidiary of Corporation F, a
publicly traded corporation. On January 1, 2010, E adopts an
employee stock purchase plan under which options for E stock are
granted to E employees.
(ii) To meet the requirements of paragraph (c)(1) of this
section, the plan must be approved by the stockholders of E (in this
case, F) within 12 months before or after January 1, 2010.
(iii) Assume the same facts as in paragraph (i) of this Example
1, except that the plan was approved by the stockholders of E (in
this case, F) on March 1, 2010. On January 1, 2012, E changes the
plan to provide that options for F stock will be granted to E
employees under the plan. Because there is a change in the stock
available for grant under the plan, under paragraph (c)(4) of this
section, the change is considered the adoption of a new plan that
must be approved by the stockholders of E (in this case, F) within
12 months before or after January 1, 2012.
Example 2. (i) Assume the same facts as in paragraph (i) of
Example 1, except that on March 15, 2011, F completely disposes of
its interest in E. Thereafter, E continues to grant options for E
stock to E employees under the plan.
(ii) The new E options are granted under a plan that meets the
stockholder approval requirements of paragraph (c)(1) of this
section without regard to whether E seeks approval of the plan from
the stockholders of E after F disposes of its interest in E.
(iii) Assume the same facts as in paragraph (i) of this Example
2, except that under the plan as adopted on January 1, 2010, only
options for F stock are granted to E employees. Assume further that,
after F disposes of its interest in E, E changes the plan to provide
for the grant of options for E stock to E employees. Because there
is a change in the stock available for purchase or grant under the
plan, under paragraph (c)(4) of this section, the stockholders of E
must approve the plan within 12 months before or after the change to
the plan to meet the stockholder approval requirements of paragraph
(c) of this section.
Example 3. (i) Corporation G maintains an employee stock
purchase plan providing options for G stock. Corporation H does not
maintain an employee stock purchase plan. On May 15, 2010, G and H
consolidate under State law to form one corporation. The new
corporation is named Corporation H. The consolidation agreement
describes the G plan, including the maximum aggregate number of
shares available for issuance under the plan after the
consolidation. Additionally, the consolidation agreement states that
the plan will be continued by H after the consolidation. The
consolidation agreement is approved by the stockholders of G and H
on May 1, 2010. H assumes the plan formerly maintained by G and
continues to grant options under the plan to all eligible employees,
but the options are for H stock.
(ii) Because there is a change in the granting corporation (from
G to H) and the stock available for purchase, under paragraph (c)(4)
of this section, H 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 under the plan, the approval of the consolidation agreement
by the stockholders constitutes approval of the plan. Thus, the
stockholder approval of the consolidation agreement satisfies the
stockholder approval requirements of paragraph (c)(1) of this
section, and the plan is considered to be adopted by H and approved
by its stockholders on May 1, 2010.
Example 4. Corporation I adopts an employee stock purchase plan
on November 1, 2010. On that date, there are two million shares of I
stock outstanding. The plan provides that the maximum aggregate
number of shares that may be issued under the plan may not exceed 15
percent of the number of shares of I stock outstanding on November
1, 2010. Because the maximum aggregate number of shares that may be
issued under the plan is designated in the plan, the requirements of
paragraph (c)(3) of this section are met.
Example 5. (i) Corporation J adopts an employee stock purchase
plan on March 15, 2010. The plan provides that the maximum aggregate
number of shares of J stock 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. Because the
maximum aggregate number of shares is not designated under the plan,
the requirements of paragraph (c)(3) of this section are not met.
(ii) Assume the same facts as in paragraph (i) of this Example
5, 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 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 (c)(3) of this section are met.
(d) Options granted to certain shareholders--(1) An employee stock
purchase plan or offering must, by its terms, provide that an employee
cannot be granted an option if the employee, immediately after the
option is granted, owns stock possessing 5 percent or more of the total
combined voting power or value of all classes of stock of the employer
corporation or a related corporation. In determining whether the stock
ownership of an employee equals or exceeds this 5 percent limit, the
rules of section 424(d) (relating to attribution of stock ownership)
shall apply, and stock that the employee may purchase under outstanding
options (whether or not the options qualify for the special tax
treatment afforded by section 421(a)) shall be treated as stock owned
by the employee. An option is outstanding for purposes of this
paragraph (d) although under its terms it may be exercised only in
installments or after the expiration of a fixed period of time. If an
option is granted to an employee whose stock ownership (as determined
under this paragraph (d)) exceeds the limitation set forth in this
paragraph (d), no portion of the option will be treated as having been
granted under an employee stock purchase plan.
[[Page 59081]]
(2) The determination of the percentage of the total combined
voting power or value of all classes of stock of the employer
corporation (or a related corporation) that is owned by the employee is
made by comparing the voting power or value of the shares owned (or
treated as owned) by the employee to the aggregate voting power or
value of all shares actually issued and outstanding immediately after
the grant of the option to the employee. The aggregate voting power or
value of all shares actually issued and outstanding immediately after
the grant of the option does not include the voting power or value of
treasury shares or shares authorized for issue under outstanding
options held by the employee or any other person.
(3) Examples. The following examples illustrate the principles this
paragraph (d):
Example 1. Employee V, an employee of Corporation K, owns 6,000
shares of K common stock, the only class of K stock outstanding. K
has 100,000 shares of its common stock outstanding. Because V owns 6
percent of the combined voting power or value of all classes of K
stock, K cannot grant an option to V under K's employee stock
purchase plan. If V's father and brother each owned 3,000 shares of
K stock and V did not own any K stock, then the result would be the
same because, under section 424(d), an individual is treated as
owning stock held by the person's father and brother. Similarly, the
result would be the same if, instead of actually owning 6,000
shares, V merely held an option on 6,000 shares of K stock,
irrespective of whether the transfer of stock under the option could
qualify for the special tax treatment of section 421, because this
paragraph (d) provides that stock the employee may purchase under
outstanding options is treated as stock owned by such employee.
Example 2. Assume the same facts as in Example 1, except that K
is a 50 percent subsidiary corporation of Corporation L.
Irrespective of whether V owns any L stock, V cannot receive an
option from L under L's employee stock purchase plan because he owns
5 percent of the total combined voting power of all classes of stock
of a subsidiary of L, in this example, K. An employee who owns (or
is treated as owning) stock in excess of the limitation of this
paragraph (d), in any corporation in a group of related
corporations, consisting of a parent and its subsidiary
corporations, cannot receive an option under an employee stock
purchase plan from any corporation in the group.
Example 3. Employee U is an employee of Corporation M. M has
only one class of stock, of which 100,000 shares are issued and
outstanding. Assuming U does not own (and is not treated as owning)
any stock in M or in any related corporation of M, M may grant an
option to U under its employee stock purchase plan for 4,999 shares,
because immediately after the grant of the option, U would not own 5
percent or more of the combined voting power or value of all classes
of M stock actually issued and outstanding at such time. The 4,999
shares that U would be treated as owning under this paragraph (d)
would not be added to the 100,000 shares actually issued and
outstanding immediately after the grant for purposes of determining
whether U's stock ownership exceeds the limitation of this paragraph
(d).
Example 4. Assume the same facts as in Example 3 but instead of
an option for 4,999 shares, M grants U an option, purportedly under
its employee stock purchase plan, for 5,000 shares. No portion of
this option will be treated as granted under an employee stock
purchase plan because U's stock ownership exceeds the limitation of
this paragraph (d).
(e) Employees covered by plan--(1) Subject to the provisions of
this paragraph (e) and the limitations of paragraphs (d), (f) and (i)
of this section, an employee stock purchase plan or offering must, by
its terms, provide that options are to be granted to all employees of
any corporation whose employees are granted any of such options by
reason of their employment by that corporation, except that one or more
of the following categories of employees may be excluded from the
coverage of the plan or offering--
(i) Employees who have been employed less than two years;
(ii) Employees whose customary employment is 20 hours or less per
week;
(iii) Employees whose customary employment is for not more than
five months in any calendar year; and
(iv) Highly compensated employees (within the meaning of section
414(q)).
(2) A plan or offering does not fail to satisfy the coverage
provision of paragraph (e)(1) of this section in the following
circumstances--
(i) The plan or offering excludes employees who have completed a
shorter period of service or whose customary employment is for fewer
hours per week or fewer months in a calendar year than is specified in
paragraphs (e)(1)(i), (ii) and (iii) of this section, provided the
exclusion is applied in an identical manner to all employees of every
corporation whose employees are granted options under the plan or
offering.
(ii) The plan or offering excludes highly compensated employees
(within the meaning of section 414(q)) with compensation above a
certain level or who are officers or subject to the disclosure
requirements of section 16(a) of the Securities Exchange Act of 1934,
provided the exclusion is applied in an identical manner to all highly
compensated employees of every corporation whose employees are granted
options under the plan or offering.
(3) Notwithstanding paragraph (e)(1) of this section, employees who
are citizens or residents of a foreign jurisdiction (without regard to
whether they are also citizens of the United States or resident aliens
(within the meaning of section 7701(b)(1)(A))) may be excluded from the
coverage of an employee stock purchase plan or offering under the
following circumstances--
(i) The grant of an option under the plan or offering to a citizen
or resident of the foreign jurisdiction is prohibited under the laws of
such jurisdiction; or
(ii) Compliance with the laws of the foreign jurisdiction would
cause the plan or offering to violate the requirements of section 423.
(4) No option granted under a plan or offering that excludes from
participation any employees, other than those who may be excluded under
this paragraph (e), and those barred from participation by reason of
paragraphs (d), (f) and (i) of this section, can be regarded as having
been granted under an employee stock purchase plan. If an option is not
granted to any employee who is entitled to the grant of an option under
the terms of the plan or offering, none of the options granted under
such offering will be treated as having been granted under an employee
stock purchase plan. However, a plan that, by its terms, permits all
eligible employees to elect to participate in an offering will not
violate the requirements of this paragraph solely because eligible
employees who elect not to participate in the offering are not granted
options pursuant to such offering.
(5) For purposes of this paragraph (e), the existence of the
employment relationship between an individual and the corporation
participating under the plan will be determined under Sec. 1.421-1(h).
(6) Examples. The following examples illustrate the principles of
this paragraph (e):
Example 1. Corporation N has a stock purchase plan that meets
all the requirements of paragraphs (a)(2) and (a)(3) of this section
except that options are not required to be granted to employees
whose weekly rate of pay is less than $1,000. As a matter of
corporate practice, however, N grants options under its plan to all
employees, irrespective of their weekly rate of pay. Even though N's
plan is operated in compliance with the requirements of this
paragraph (e), N's plan is not an employee stock purchase plan
because the terms of the plan exclude a category of employees that
is not permitted under this paragraph (e).
Example 2. Assume the same facts as in Example 1, except that
the first offering under N's plan provides that options will be
granted to all employees of N. The terms of
[[Page 59082]]
the first offering will be treated as part of the terms of N's plan,
but only for purposes of the first offering. Because the terms of
the first offering satisfy the requirements of this paragraph (e),
stock transferred pursuant to options exercised under the first
offering will be treated as stock transferred pursuant to the
exercise of options granted under an employee stock purchase plan
for purposes of section 421.
Example 3. Corporation O has a stock purchase plan that excludes
from participation all employees who have been employed less than
one year. Assuming all other requirements of paragraphs (a)(2) and
(a)(3) of this section are satisfied, O's plan qualifies as an
employee stock purchase plan under section 423.
Example 4. Corporation P has a stock purchase plan that excludes
from participation clerical employees who have been employed less
than two years. However, non-clerical employees with less than two
years of service are permitted to participate in the plan. P's plan
is not an employee stock purchase plan because the exclusion of
employees who have been employed less than two years applies only to
certain employees of P and is not applied in an identical manner to
all employees of P. If, instead, P's plan excludes from
participation all employees (both clerical and non-clerical) who
have been employed less than two years, then P's plan would qualify
as an employee stock purchase plan under section 423 assuming all
other requirements of paragraphs (a)(2) and (a)(3) of this section
are satisfied.
Example 5. Corporation Q has a stock purchase plan that excludes
from participation all officers who are highly compensated employees
(within the meaning of section 414(q)). Assuming all other
requirements of paragraphs (a)(2) and (a)(3) of this section are
satisfied, Q's plan qualifies as an employee stock purchase plan
under section 423.
Example 6. Corporation R maintains an employee stock purchase
plan that excludes from participation all highly compensated
employees (within the meaning of section 414(q)), except highly
compensated employees who are officers of R. R's plan is not an
employee stock purchase plan because the exclusion of all highly
compensated employees except highly compensated employees who are
officers of R is not a permissible exclusion under paragraph
(e)(2)(ii) of this section.
Example 7. Corporation S is the parent corporation of Subsidiary
YY and Subsidiary ZZ. S maintains an employee stock purchase plan
with both YY and ZZ participating in the same offering under the
plan. Under the terms of the offering under the plan, all employees
of YY and ZZ are permitted to participate in the plan with the
exception of ZZ's highly compensated employees with annual
compensation greater than $300,000. None of the options granted
under the offering will be considered granted under an employee
stock purchase plan because the exclusion of highly compensated
employees with annual compensation greater than $300,000 is not
applied in an identical manner to all employees of YY and ZZ granted
options in the same offering.
Example 8. Assume the same facts as in Example 7, except that
Corporation S establishes separate offerings under the plan for YY
and ZZ. Under the terms of the separate offering for YY, all
employees of YY are permitted to participate in the plan. Under the
terms of the separate offering established for ZZ, all employees of
ZZ are permitted to participate in the plan with the exception of
ZZ's highly compensated employees with annual compensation greater
than $300,000. The options granted under the separate offering for
YY will be considered granted under an employee stock purchase plan.
Further, the options granted under the separate offering for ZZ will
be considered granted under an employee stock purchase plan because
the exclusion of highly compensated employees with annual
compensation greater than $300,000 is applied in an identical manner
to all employees of ZZ granted options in the same offering.
Example 9. The laws of Country A require that options granted to
residents of Country A be transferable during the lifetime of the
option recipient. Corporation T has a stock purchase plan that
excludes residents of Country A from participation in the plan.
Because compliance with the laws of Country A would cause options
granted to residents of Country A to violate paragraph (j) of this
section, T may exclude residents of Country A from participation in
the plan. Assuming all other requirements of paragraph (a)(2) of
this section are satisfied, T's plan qualifies as an employee stock
purchase plan under section 423.
(f) Equal rights and privileges--(1) Except as otherwise provided
in paragraphs (f)(2) through (f)(6) of this section, an employee stock
purchase plan or offering must, by its terms, provide that all
employees granted options under the plan or offering shall have the
same rights and privileges. Thus, the provisions applying to one option
under an offering (such as the provisions relating to the method of
payment for the stock and the determination of the purchase price per
share) must apply to all other options under the offering in the same
manner. If all the options granted under a plan or offering do not, by
their terms, give the respective optionees the same rights and
privileges, none of the options will be treated as having been granted
under an employee stock purchase plan for purposes of section 421.
(2) The requirements of this paragraph (f) do not prevent the
maximum amount of stock that an employee may purchase from being
determined on the basis of a uniform relationship to the total
compensation, or the basic or regular rate of compensation, of all
employees.
(3) A plan or offering will not fail to satisfy the requirements of
this paragraph (f) because the plan or offering provides that no
employee may purchase more than a maximum amount of stock fixed under
the plan or offering.
(4) A plan or offering will not fail to satisfy the requirements of
this paragraph (f) if, in order to comply with the laws of a foreign
jurisdiction, the terms of an option granted under a plan or offering
to citizens or residents of such foreign jurisdiction (without regard
to whether they are also citizens of the United States or resident
aliens (within the meaning of section 7701(b)(1)(A))) are less
favorable than the terms of options granted under the same plan or
offering to employees resident in the United States.
(5)(i) Except as provided in this paragraph and paragraph
(f)(5)(ii) of this section, a plan or offering permitting one or more
employees to carry forward amounts that were withheld but not applied
toward the purchase of stock under an earlier plan or offering and
apply the amounts towards the purchase of additional stock under a
subsequent plan or offering will be a violation of the equal rights and
privileges under paragraph (f)(1) of this section. However, the carry
forward of amounts withheld but not applied toward the purchase of
stock under an earlier plan or offering will not violate the equal
rights and privileges requirement of paragraph (f)(1) of this section,
if all other employees participating in the current plan or offering
are permitted to make direct payments toward the purchase of shares
under a subsequent plan or offering in an amount equal to the excess of
the greatest amount which any employee is allowed to carry forward from
an earlier plan or offering over the amount, if any, the employee will
carry forward from an earlier plan or offering.
(ii) A plan or offering will not fail to satisfy the requirements
of this section merely because employees are permitted to carry forward
amounts representing a fractional share, that were withheld but not
applied toward the purchase of stock under an earlier plan or offering
and apply the amounts toward the purchase of additional stock under a
subsequent plan or offering.
(6) Paragraph (f) does not prohibit the delaying of the grant of an
option to any employee who is barred from being granted an option
solely by reason of the employee's failing to meet a minimum service
requirement set forth in paragraph (e)(1) of this section until the
employee meets such requirement.
(7) Examples. The following examples illustrate the principles of
this paragraph (f):
Example 1. Corporation U has an employee stock purchase plan
that provides
[[Page 59083]]
that the maximum amount of stock that each employee may purchase
under the offering is one share for each $100 of annual gross pay.
The plan meets the requirements of this paragraph (f).
Example 2. Corporation V has an employee stock purchase plan
that provides that the maximum amount of stock that each employee
may purchase under the offering is one share for each $100 of annual
gross pay up to and including $10,000, and two shares for each $100
of annual gross pay in excess of $10,000. The plan will not meet the
requirements of this paragraph (f) because the amount of stock that
may be purchased under the plan is not based on a uniform
relationship to the total compensation of all employees.
Example 3. Corporation W has an employee stock purchase plan
that provides that options to purchase stock in an amount equal to
ten percent of an employee's annual salary at a price equal to 85
percent of the fair market value on the first day of the offering
will be granted to all employees other than those who have been
employed less than 18 months. In addition, the plan provides that
employees who have not yet met the minimum service requirements on
the first day of the offering will be granted similar options on the
date the 18 month service requirement has been attained. The plan
meets the requirements of this paragraph (f).
Example 4. Corporation X is the parent corporation of
Subsidiary AA, Subsidiary BB and Subsidiary CC. X maintains an
employee stock purchase plan with AA, BB and CC participating in the
same offering under the plan. Under the terms of the offering under
the plan, options to purchase stock at a price equal to 90 percent
of the fair market value at the time the option is exercised will be
granted to all employees. Certain employees of AA are residents of
Country B. The laws of Country B provide that options granted to
employees who are residents of Country B must have a purchase price
not less than 95 percent of the fair market value at the time the
option is exercised. The plan will not fail to satisfy the
requirements of this paragraph (f) merely because the residents of
Country B are granted options under the plan to purchase stock at a
price equal to 95 percent of the fair market value at the time the
option is exercised.
Example 5. Assume the same facts as in Example 4, except that
Corporation X establishes two separate offerings under the plan: A
separate offering for the employees of AA and a separate offering
for the employees of BB and CC. Under the separate offering for the
employees of BB and CC, options are granted to all employees with an
exercise price equal to 90 percent of the fair market value at the
time the option is exercised. Under the separate offering for the
employees of AA, options are granted to all employees with an
exercise price equal to 95 percent of the fair market value at the
time the option is exercised. The plan does not violate the equal
rights and privileges requirement of this paragraph (f) merely
because the exercise price of options granted under one offering is
less than the exercise price of options granted under a separate
offering.
Example 6. Corporation Y maintains an employee stock purchase
plan. Employee T is employed by Y. T is granted an option under the
current offering to purchase a maximum of 100 shares of Y stock at
an option price equal to 85 percent of the fair market value of the
stock at exercise. The plan permits the carry forward of withheld
but unused amounts from an earlier offering. Prior to the exercise
date, $2000 of T's salary has been withheld and is available to be
applied toward the purchase of Y stock. On the exercise date, the
fair market value of Y stock is $20 per share. T is able to purchase
100 shares of Y stock at $17 per share for an aggregate purchase
price of $1700. T can carry forward $300 to the subsequent offering.
Each employee in the subsequent offering other than T will be
permitted to make direct payments toward the purchase of shares
under the subsequent offering in a maximum amount of $300 less any
amount the employee has carried forward from an earlier offering.
The plan does not violate the equal rights and privileges
requirement of this paragraph (f).
(g) Option price--(1) An employee stock purchase plan or offering
must, by its terms, provide that the option price will not be less than
the lesser of--
(i) An amount equal to 85 percent of the fair market value of the
stock at the time the option is granted, or
(ii) An amount that under the terms of the option may not be less
than 85 percent of the fair market value of the stock at the time the
option is exercised.
(2) For purposes of determining the option price, the fair market
value of the stock may be determined in any reasonable manner,
including the valuation methods permitted under Sec. 20.2031-2.
However, the option price must meet the minimum pricing requirements of
this paragraph (g). For general rules relating to the option price, see
Sec. 1.421-1(e). For rules relating to the determination of when an
option is granted, see Sec. Sec. 1.421-1(c) and 1.423-2(h)(2). Any
option that does not meet the minimum pricing requirements of this
paragraph (g) will not be treated as an option granted under an
employee stock purchase plan irrespective of whether the plan or
offering satisfies those requirements. If an option that does not meet
the minimum pricing requirements is granted to an employee who is
entitled to the grant of an option under the terms of the plan or
offering, and the employee is not granted an option under such offering
that qualifies as an option granted under an employee stock purchase
plan, the offering will not meet the requirements of paragraph (e) of
this section. Accordingly, none of the options granted under the
offering will be eligible for the special tax treatment of section 421.
(3) The option price may be stated either as a percentage or as a
dollar amount. If the option price is stated as a dollar amount, then
the requirement of this paragraph (g) can only be met by a plan or
offering in which the price is fixed at not less than 85 percent of the
fair market value of the stock at the time the option is granted. If
the fixed price is less than 85 percent of the fair market value of the
stock at grant, then the option cannot meet the requirement of this
paragraph (g) even if a decline in the fair market value of the stock
results in such fixed price being not less than 85 percent of the fair
market value of the stock at the time the option is exercised, because
that result was not certain to occur under the terms of the option.
(4) Examples. The following examples illustrate the principles of
this paragraph (g):
Example 1. Corporation Z has an employee stock purchase plan
that provides that the option price will be 85 percent of the fair
market value of the stock on the first day of the offering (which is
the date of grant in this case), or 85 percent of the fair market
value of the stock at exercise, whichever amount is the lesser. Upon
the exercise of an option issued under Z's plan, Z agrees to accept
an option price that is less than the minimum amount allowable under
the terms of such plan. Notwithstanding that the option was issued
under an employee stock purchase plan, the transfer of stock
pursuant to the exercise of such option does not satisfy the
requirement of this paragraph (g) and cannot qualify for the special
tax treatment of section 421.
Example 2. Corporation AA has an employee stock purchase plan
that provides that the option price is set at 85 percent of the fair
market value of AA stock at exercise, but not less than $80 per
share. On the first day of the offering (which is the date of grant
in this case), the fair market value of AA stock is $100 per share.
The option satisfies the requirement of this paragraph (g), and can
qualify for the special tax treatment of section 421.
Example 3. Assume the same facts as in Example 2, except that
the option price is set at 85 percent of the fair market value of AA
stock at exercise, but not more than $80 per share. This option
cannot satisfy the requirement of this paragraph (g) irrespective of
whether, at the time the option is exercised, 85 percent of the fair
market value of AA stock is $80 or less.
(h) Option period--(1) An employee stock purchase plan or offering
must, by its terms, provide that options granted under the plan cannot
be exercised after the expiration of 27 months from the date of grant
unless, under the terms of the plan or offering, the option price is
not less than 85 percent of the fair market value of the stock at the
time of the exercise of the option. If the option price is not less
than 85 percent of the fair market value of the stock at the time the
option is exercised, then the option period provided under the plan
must
[[Page 59084]]
not exceed five years from the date of grant. If the requirements of
this paragraph (h) are not met by the terms of the plan or offering,
then options issued under such plan or offering will not be treated as
options granted under an employee stock purchase plan irrespective of
whether the options, by their terms, are exercisable beyond the period
allowable under this paragraph (h). An option that provides that the
option price is not less than 85 percent of the fair market value of
the stock at exercise may have an option period of 5 years irrespective
of whether the fair market value of the stock at exercise is more or
less than the fair market value of the stock at grant. However, if the
option provides that the option price is 85 percent of the fair market
value of the stock at exercise, but not more than some other fixed
amount determined in accordance with the provisions of paragraph (g) of
this section, then irrespective of the price paid on exercise, the
option period must not be more than 27 months.
(2) Section 1.421-1(c) provides that, for purposes of Sec. Sec.
1.421-1 through 1.424-1, the language ``the date of the granting of the
option'' and the ``time such option is granted,'' 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. With
respect to options granted under an employee stock purchase plan, the
principles of Sec. 1.421-1(c) shall be applied without regard to the
requirement that the minimum option price must be fixed or determinable
in order for the corporate action constituting an offer of stock to be
considered complete.
(3) The date of grant will be the first day of an offering if the
terms of an employee stock purchase plan or offering designate a
maximum number of shares that may be purchased by each employee during
the offering. Similarly, the date of grant will be the first day of an
offering if the terms of the plan or offering require the application
of a formula to establish, on the first day of the offering, the
maximum number of shares that may be purchased by each employee during
the offering. It is not required that an employee stock purchase plan
or offering designate a maximum number of shares that may be purchased
by each employee during the offering or incorporate a formula to
establish a maximum number of shares that may be purchased by each
employee during the offering. If the maximum number of shares that can
be purchased under an option is not fixed or determinable until the
date the option is exercised, then the date of exercise will be the
date of grant of the option.
(4) Examples. The following examples illustrate the principles of
this paragraph (h):
Example 1. (i) Corporation BB has an employee stock purchase
plan that provides that the option price will be the lesser of 85
percent of the fair market value of the stock on the first day of an
offering or 85 percent of the fair market value of the stock on the
last day of the offering. Options are exercised on the last day of
the offering. One million shares of BB stock are reserved for
issuance under the plan. The plan provides that no employee may be
permitted to purchase stock under the plan at a rate that exceeds
$25,000 in fair market value of the BB stock (determined on the date
of grant) for each calendar year during which an option granted to
the employee is outstanding. The terms of each option granted under
an offering provide that a maximum of 500 shares may be purchased by
the option recipient during the offering. Because the maximum number
of shares that can be purchased under the option is fixed and
determinable on the first day of the offering, the date of grant for
the option is the first day of the offering.
(ii) Assume the same facts as in paragraph (i) of Example 1,
except that BB's plan excludes all employees who have been employed
less than 18 months. The plan provides that employees who have not
yet met the minimum service requirements on the first day of an
offering will be granted an option on the date the 18-month service
requirement has been attained. With respect to those employees who
have been employed less than 18 months on the first day of an
offering, the date of grant for the option is the date the 18-month
service requirement has been attained.
Example 2. Assume the same facts as in paragraph (i) of Example
1, except that the terms of each option granted do not provide that
a maximum of 500 shares may be purchased by the option recipient
during the offering. Notwithstanding the fixed number of shares
reserved for issuance under the plan and the $25,000 limitation set
forth in the plan, the maximum number of shares that can be
purchased under the option is not fixed or determinable until the
last day of the offering when the option is exercised. Therefore the
date of grant for the option is the last day of the offering when
the option is exercised.
Example 3. Corporation CC has an employee stock purchase plan
that provides that the option price will be 85 percent of the fair
market value of the stock on the last day of the offering. Options
are exercised on the last day of the offering. Each offering under
the plan begins on January 1 and ends on December 31 of the same
calendar year. The terms of each option granted under an offering
provide that the maximum number of shares that may be purchased by
any employee during the offering equals $25,000 divided by the fair
market value of the stock on the first day of the offering. The
maximum number of shares that can be purchased under the option is
fixed and determinable on the first day of the offering and
therefore the date of grant for the option is the first day of the
offering.
Example 4. Assume the same facts as in Example 3 except that
the terms of each option granted under an offering provide that the
maximum number of shares that may be purchased by any employee
during the offering equals 10 percent of the employee's annual
salary (determined as of January 1 of the year in which the offering
commences) divided by the fair market value of the stock on the
first day of the offering. The maximum number of shares that can be
purchased under the option is fixed and determinable on the first
day of the offering and therefore the date of grant for the option
is the first day of the offering.
(i) Annual $25,000 limitation--(1) An employee stock purchase plan
or offering must, by its terms, provide that no employee may be
permitted to purchase stock under all the employee stock purchase plans
of the employer corporation and its related corporations at a rate that
exceeds $25,000 in fair market value of the stock (determined at the
time the option is granted) for each calendar year in which any option
granted to the employee is outstanding at any time. In applying the
foregoing limitation--
(i) The right to purchase stock under an option accrues when the
option (or any portion thereof) first becomes exercisable during the
calendar year;
(ii) The right to purchase stock under an option accrues at the
rate provided in the option, but in no case may such rate exceed
$25,000 of fair market value of such stock (determined at the time such
option is granted) for any one calendar year; and
(iii) A right to purchase stock that has accrued under one option
granted pursuant to the plan may not be carried over to any other
option.
(2) If an option is granted under an employee stock purchase plan
that satisfies the requirement of this paragraph (i), but the option
gives the optionee the right to buy stock in excess of the maximum rate
allowable under this paragraph (i), then no portion of the option will
be treated as having been granted under an employee stock purchase
plan. Furthermore, if the option was granted to an employee entitled to
the grant of an option under the terms of the plan or offering, and the
employee is not granted an option under the offering that qualifies as
an option granted under an employee stock purchase plan, then the
offering will not meet the requirements of paragraph (e) of this
section. Accordingly, none of the options granted under the offering
will be eligible for the special tax treatment of section 421.
[[Page 59085]]
(3) The limitation of this paragraph (i) applies only to options
granted under employee stock purchase plans and does not limit the
amount of stock that an employee may purchase under incentive stock
options (as defined in section 422(b)) or any other stock options
except those to which section 423 applies. Stock purchased under
options to which section 423 does not apply will not limit the amount
that an employee may purchase under an employee stock purchase plan,
except for purposes of the 5-percent stock ownership provision of
paragraph (d) of this section.
(4) Under the limitation of this paragraph (i), an employee may
purchase up to $25,000 of stock (based on the fair market value of the
stock at the time the option was granted) in each calendar year during
which an option granted to the employee under an employee stock
purchase plan is outstanding. Alternatively, an employee may purchase
more than $25,000 of stock (based on the fair market value of such
stock at the time the option was granted) in a calendar year, so long
as the total amount of stock that the employee purchases does not
exceed $25,000 in fair market value of the stock (determined at the
time the option was granted) for each calendar year in which any option
was outstanding. If, in any calendar year, the employee holds two or
more outstanding options granted under employee stock purchase plans of
the employer corporation, or a related corporation, then the employee's
purchases of stock attributable to that year under all options granted
under employee stock purchase plans must not exceed $25,000 in fair
market value of the stock (determined at the time the options were
granted). Under an employee stock purchase plan, an employee may not
purchase stock in anticipation that the option will be outstanding in
some future year. Thus, the employee may purchase only the amount of
stock that does not exceed the limitation of this paragraph (i) for the
year of the purchase and for preceding years during which the option
was outstanding. Thus, the amount of stock that may be purchased under
an option depends on the number of years in which the option is
actually outstanding. The amount of stock that may be purchased under
an employee stock purchase plan may not be increased by reason of the
failure to grant an option in an earlier year under such plan, or by
reason of the failure to exercise an earlier option. For example, if an
option is granted to an individual and expires without having been
exercised at all, then the failure to exercise the option does not
increase the amount of stock which such individual may be permitted to
purchase under an option granted in a year following the year of such
expiration. If an option granted under an employee stock purchase plan
is outstanding in more than one calendar year, then stock purchased
pursuant to the exercise of such an option will be applied first, to
the extent allowable under this paragraph (i), against the $25,000
limitation for the earliest year in which the option was outstanding,
then, against the $25,000 limitation for each succeeding year, in
order.
(5) Examples. The following examples illustrate the principles of
this paragraph (i):
Example 1. Assume that Corporation DD maintains an employee
stock purchase plan and that Employee S is employed by DD. On June
1, 2010, DD grants S an option under the plan to purchase a total of
750 shares of DD stock at $85 per share. On that date, the fair
market value of DD stock is $100 per share. The option provides that
it may be exercised at any time but cannot be exercised after May
31, 2012. Under this paragraph (i), the option must not permit S to
purchase more than 250 shares of DD stock during the calendar year
2010, because 250 shares are equal to $25,000 in fair market value
of DD stock determined at the time of grant. During the calendar
year 2011, S may purchase under the option an amount of DD stock
equal to the difference between $50,000 in fair market value of DD
stock (determined at the time the option was granted) and the fair
market value of DD stock (determined at the time of grant of the
option) purchased during the year 2010. During the calendar year
2012, S may purchase an amount of DD stock equal to the difference
between $75,000 in fair market value of the stock (determined at the
time of grant of the option) and the total amount of the fair market
value of the stock (determined at the time of grant of the option)
purchased under the option during the calendar years 2010 and 2011.
S may purchase $25,000 of stock for the year 2010, and $25,000 of
stock for the year 2012, although the option was outstanding for
only a part of each of such years. However, S may not be granted
another option under an employee stock purchase plan of DD or a
related corporation to purchase stock of DD or a related corporation
during the calendar years 2010, 2011, and 2012, so long as the
option granted June 1, 2010, is outstanding.
Example 2. Assume the same facts as in Example 1, except that
the option granted to S in 2010 is terminated in 2011 without any
part of the option having been exercised, and that subsequent to the
termination and during 2011, S is granted another option under DD's
employee stock purchase plan. Under that option, S may be permitted
to purchase $25,000 of stock for 2011. The failure of S to exercise
the option granted to S in 2010, does not increase the amount of
stock that S may be permitted to purchase under the option granted
to S in 2011.
Example 3. Assume the same facts as in Example 1, except that,
on May 31, 2012, S exercised the option granted to S in 2010, and
purchased 600 shares of DD stock. Five hundred shares, the maximum
amount of stock that could have been purchased in 2011, under the
option, are treated as having been purchased for the years 2010 and
2011. Only 100 shares of the stock are treated as having been
purchased for 2012. After S's exercise of the option on May 31,
2012, S is granted another option under DD's employee stock purchase
plan. S may be permitted under the new option to purchase for 2012
stock having a fair market value of no more than $15,000 at the time
the new option is granted.
Example 4. Corporation EE maintains an employee stock purchase
plan and Employee R is employed by EE. On August 1, 2010, EE grants
R an option under the plan to purchase 150 shares of EE stock at $85
per share during each of the calendar years 2010, 2011, and 2012. On
that date, the fair market value of EE stock is $100 per share. The
option provides that it may be exercised at any time during years
2010, 2011, and 2012. Because this option permits R to purchase only
$15,000 of EE's stock for each year the option is outstanding, R
could be granted another option by EE, or by a related corporation,
in year 2010, permitting R to purchase an additional $10,000 of
stock during each of the calendar years 2010, 2011, and 2012.
Example 5. Corporation FF maintains an employee stock purchase
plan and Employee Q is employed by FF. On September 1, 2010, FF
grants Q an option under the plan that will be automatically
exercised on August 31, 2011, and August 31, 2012. The terms of the
option provide that no more than 150 shares may be purchased on each
date that the option is automatically exercised. On August 31, 2011,
Q may purchase under the option an amount of FF stock equal to
$50,000 in fair market value of FF stock (determined at the time the
option was granted). On August 31, 2012, Q may purchase under the
option an amount of FF stock equal to the difference between $75,000
in fair market value of Q stock (determined at the time the option
was granted) and the fair market value of Q stock (determined at the
time of grant of the option) purchased during year 2011.
(j) Restriction on transferability. An employee stock purchase plan
or offering must, by its terms, provide that options granted under the
plan are not transferable by the optionee other than by will or the
laws of descent and distribution, and must be exercisable, during the
optionee's lifetime, only by the optionee. For general rules relating
to the restriction on transferability required by this paragraph (j),
see Sec. 1.421-1(b)(2). For a limited exception to the requirement of
this paragraph (j), see section 424(h)(3).
(k) Special rule where option price is between 85 percent and 100
percent of value of stock--(1)(i) If all the conditions necessary for
the application of section 421(a) exist, this paragraph (k)
[[Page 59086]]
provides additional rules that are applicable in cases where, at the
time the option is granted, the option price per share is less than 100
percent (but not less than 85 percent) of the fair market value of the
share. In that case, upon the disposition of the share by the employee
after the expiration of the two-year and the one-year holding periods,
or upon the employee's death while owning the share (whether occurring
before or after the expiration of such periods), there shall be
included in the employee's gross income as compensation (and not as
gain upon the sale or exchange of a capital asset) the lesser of--
(A) The amount, if any, by which the price paid under the option
was exceeded by the fair market value of the share at the time the
option was granted, or
(B) The amount, if any, by which the price paid under the option
was exceeded by the fair market value of the share at the time of such
disposition or death.
(ii) For purposes of applying the rules of this paragraph (k), if
the option price is not fixed or determinable at the time the option is
granted, the option price will be computed as if the option had been
exercised at such time. The amount of compensation resulting from the
application of this paragraph (k) shall be included in the employee's
gross income for the taxable year in which the disposition occurs, or
for the taxable year closing with the employee's death, whichever event
results in the application of this paragraph (k).
(iii) The application of the special rules provided in this
paragraph (k) shall not affect the rules provided in section 421(a)
with respect to the employee exercising the option, the employer
corporation, or a related corporation. Thus, notwithstanding the
inclusion of an amount as compensation in the gross income of an
employee, as provided in this paragraph (k), no income results to the
employee at the time the stock is transferred to the employee, and no
deduction under section 162 is allowable at any time to the employer
corporation or a related corporation with respect to such amount.
(iv) If, during the employee's lifetime, the employee exercises an
option granted under an employee stock purchase plan, but the employee
dies before the stock is transferred to the employee pursuant to the
exercise of the option, then for the purpose of sections 421 and 423,
on the employee's death, the stock is deemed to be transferred
immediately to the employee, and immediately thereafter, the employee
is deemed to have transferred the stock to the employee's executor,
administrator, trustee, beneficiary by operation of law, heir, or
legatee, as the case may be.
(2) If the special rules provided in this paragraph (k) are
applicable to the disposition of a share of stock by an employee, then
the basis of the share in the employee's hands at the time of the
disposition, determined under section 1011, shall be increased by an
amount equal to the amount includible as compensation in the employee's
gross income under this paragraph (k). However, the basis of a share of
stock acquired after the death of an employee by the exercise of an
option granted to the employee under an employee stock purchase plan
shall be determined in accordance with the rules of section 421(c) and
Sec. 1.421-2(c). If the special rules provided in this paragraph (k)
are applicable to a share of stock upon the death of an employee, then
the basis of the share in the hands of the estate or the person
receiving the stock by bequest or inheritance shall be determined under
section 1014, and shall not be increased by reason of the inclusion
upon the decedent's death of any amount in the decedent's gross income
under this paragraph (k). See Example (9) of this paragraph (k) with
respect to the determination of basis of the share in the hands of a
surviving joint owner.
(3) Examples. The following examples illustrate the principles of
this paragraph (k):
Example 1. On June 1, 2010, Corporation GG grants to Employee P,
an employee of GG, an option under GG's employee stock purchase plan
to purchase a share of GG stock for $85. The fair market value of GG
stock on such date is $100 per share. On June 1, 2011, P exercises
the option and on that date GG transfers the share of stock to P. On
January 1, 2013, P sells the share for $150, its fair market value
on that date. P's income tax return is filed on the basis of the
calendar year. The income tax consequences to P and GG are as
follows--
(i) Compensation in the amount of $15 is includible in P's gross
income for the year 2013, the year of the disposition of the share.
The $15 represents the difference between the option price ($85) and
the fair market value of the share on the date the option was
granted ($100), because the value is less than the fair market value
of the share on the date of disposition ($150). For the purpose of
computing P's gain or loss on the sale of the share, P's cost basis
of $85 is increased by $15, the amount includible in P's gross
income as compensation. Thus, P's basis for the share is $100.
Because the share was sold for $150, P realizes a gain of $50, which
is treated as long-term capital gain; and
(ii) GG is not entitled to any deduction under section 162 at
any time with respect to the share transferred to P.
Example 2. Assume the same facts as in Example 1, except that P
sells the share of GG stock on January 1, 2014, for $75, its fair
market value on that date. Because $75 is less than the option price
($85), no amount in respect of the sale is includible as
compensation in P's gross income for the year 2014. P's basis for
determining gain or loss on the sale is $85. Because P sold the
share for $75, P realized a loss of $10 on the sale that is treated
as a long-term capital loss.
Example 3. Assume the same facts as in Example 1, except that
the option provides that the option price shall be 90 percent of the
fair market value of the stock on the day the option is exercised.
On June 1, 2011, when the option is exercised, the fair market value
of the stock is $120 per share so that P pays $108 for the share of
the stock. Compensation in the amount of $10 is includible in P's
gross income for the year 2013, the year of the disposition of the
share. This is determined in the following manner: The excess of the
fair market value of the stock at the time of the disposition ($150)
over the price paid for the share ($108) is $42; and the excess of
the fair market value of the stock at the time the option was
granted ($100) over the option price, computed as if the option had
been exercised at such time ($90), is $10. Accordingly, $10, the
lesser, is includible in gross income. In this situation, P's cost
basis of $108 is increased by $10, the amount includible in P's
gross income as compensation. Thus, P's basis for the share is $118.
Because the share was sold for $150, P realizes a gain of $32 that
is treated as long-term capital gain.
Example 4. Assume the same facts as in Example 1, except that
the option provides that the option price shall be the lesser of 95
percent of the fair market value of the stock on the first day of
the offering period and 95 percent of the fair market value of the
stock on the day the option is exercised. On June 1, 2011, when the
option is exercised, the fair market value of the stock is $120 per
share. P pays $95 for the share of the stock. Compensation in the
amount of $5 is includible in P's gross income for the year 2013,
the year of the disposition of the share. This is determined in the
following manner: The excess of the fair market value of the stock
at the time of the disposition ($150) over the price paid for the
share ($95) is $55; and the excess of the fair market value of the
stock at the time the option was granted ($100) over the option
price, computed as if the option had been exercised at such time
($95), is $5. Accordingly, $5, the lesser, is includible in gross
income. In this situation, P's cost basis of $95 is increased by $5,
the amount includible in P's gross income as compensation. Thus, P's
basis for the share is $100. Because the share was sold for $150, P
realizes a gain of $50 that is treated as long-term capital gain.
Example 5. Assume the same facts as in Example 1, except that
instead of selling the share on January 1, 2013, P makes a gift of
the share on that day. In that case $15 is includible as
compensation in P's gross income for 2013. P's cost basis of $85 is
increased by $15, the amount includible in P's gross income as
compensation. Thus, P's basis for the share is $100, which becomes
[[Page 59087]]
the donee's basis, as of the time of the gift, for determining gain
or loss.
Example 6. Assume the same facts as in Example 2, except that
instead of selling the share on January 1, 2014, P makes a gift of
the share on that date. Because the fair market value of the share
on that day ($75) is less than the option price ($85), no amount in
respect of the disposition by way of gift is includible as
compensation in P's gross income for 2014. P's basis for the share
is $85, which becomes the donee's basis, as of the time of the gift,
for the purpose of determining gain. The donee's basis for the
purpose of determining loss, determined under section 1015(a), is
$75 (fair market value of the share at the date of gift).
Example 7. Assume the same facts as in Example 1, except that
after acquiring the share of stock on June 1, 2011, P dies on August
1, 2012, at which time the share has a fair market value of $150.
Compensation in the amount of $15 is includible in P's gross income
for the taxable year closing with P's death, $15 being the
difference between the option price ($85) and the fair market value
of the share when the option was granted ($100), because such value
is less than the fair market value at date of death ($150). The
basis of the share in the hands of P's estate is determined under
section 1014 without regard to the $15 includible in the decedent's
gross income.
Example 8. Assume the same facts as in Example 7, except that P
dies on August 1, 2011, at which time the share has a fair market
value of $150. Although P's death occurred within one year after the
transfer of the share to P, the income tax consequences are the same
as in Example 7.
Example 9. Assume the same facts as in Example 1, except that
the share of stock was issued in the names of P and P's spouse
jointly with right of survivorship, and that P and P's spouse sold
the share on June 15, 2012, for $150, its fair market value on that
date. Compensation in the amount of $15 is includible in P's gross
income for the year 2012, the year of the disposition of the share.
The basis of the share in the hands of P and P's spouse for the
purpose of determining gain or loss on the sale is $100, that is,
the cost of $85 increased by the amount of $15 includible as
compensation in P's gross income. The gain of $50 on the sale is
treated as long-term capital gain, and is divided equally between P
and P's spouse.
Example 10. Assume the same facts as in Example 1, except that
the share of stock was issued in the names of P and P's spouse
jointly with right of survivorship, and that P predeceased P's
spouse on August 1, 2012, at which time the share had a fair market
value of $150. Compensation in the amount of $15 is includible in
P's gross income for the taxable year closing with his death. See
Example 7. The basis of the share in the hands of P's spouse as
survivor is determined under section 1014 without regard to the $15
includible in the decedent's gross income.
Example 11. Assume the same facts as in Example 10, except that
P's spouse predeceased P on July 1, 2012. Section 423(c) does not
apply in respect of the death of P's spouse. Upon the subsequent
death of P on August 1, 2012, the income tax consequences in respect
of P's taxable year closing with the date of P's death, and in
respect of the basis of the share in the hands of P's estate, are
the same as in Example 7. If P had sold the share on July 15, 2012
(after the death of P's spouse), for $150, its fair market value at
that time, the income tax consequences would be the same as in
Example 1.
(l) Effective/applicability date. The regulations under this
section are effective on November 17, 2009. The regulations under this
section apply to options granted under an employee stock purchase plan
on or after January 1, 2010.
0
Par. 6. Section 1.424-1, paragraphs (a)(10) Example 9 (iii) and (g)(1)
are revised to read as follows:
Sec. 1.424-1 Definition and special rules applicable to statutory
options.
(a) * * *
(10) * * *
Example 9. * * * (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 Sec. 1.422-2(b)(2)(iii), the stockholders of X (in
this case, Y) must approve the plan within 12 months before or after
the date of the amendment of the plan. If the stockholders of X (in
this case, Y) timely approve the plan, the future grants to acquire
Y stock will be incentive stock options (assuming the other
requirements of Sec. 1.422-2 have been met).
* * * * *
(g) Effective/applicability date--(1) In general. Except for Sec.
1.424-1(a)(10) Example 9 (iii), the regulations under this section are
effective on August 3, 2004. Section 1.424-1(a)(10) Example 9 (iii) is
effective on November 17, 2009. Section 1.424-1(a)(10) Example 9 (iii)
applies to statutory options granted on or after January 1, 2010.
* * * * *
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
Approved: November 9, 2009.
Michael F. Mundaca,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E9-27452 Filed 11-16-09; 8:45 am]
BILLING CODE 4830-01-P