§421 — Title 26 Internal Revenue Code | U.S. Code

Summary

If an employee gets stock by exercising a stock option that meets the rules in section 422(a) or 423(a), the employee does not have to report income when the stock is transferred. The employer, its parent or subsidiary, or a corporation that issues or assumes the option under section 424(a) cannot take a business deduction for that stock, and only the option price counts as what the company received. If the option would have qualified except for missing a required holding period, any extra income for the worker or extra deduction for the employer from selling the stock is taxed in the year the sale happened. No amount must be withheld under chapter 24 for that income. If the option is exercised after the employee’s death by the estate or an heir, the same no-income rule applies as if the employee had exercised, but the holding-period and employment tests in sections 422(a) and 423(a) do not apply. A transfer by the estate is treated as a disposition under section 423(c). If the estate or heir must include income under section 423(c), they get an estate-tax related deduction figured under section 691(c). The share’s tax basis includes the part of the option’s basis that applies to the share, reduced by any excess of the income that would have been reported if the decedent had exercised before death over the income actually reported; a special limit on section 423(c) applies only when the included income is larger than that option basis. Finally, subsection (d) begins a rule about eligible persons who get stock and then dispose of it under a certificate of divestiture.

Title 26, §421

Internal Revenue Code — Source: USLM XML via OLRC

(a)If a share of stock is transferred to an individual in a transfer in respect of which the requirements of section 422(a) or 423(a) are met—

(1)no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share;

(2)no deduction under section 162 (relating to trade or business expenses) shall be allowable at any time to the employer corporation, a parent or subsidiary corporation of such corporation, or a corporation issuing or assuming a stock option in a transaction to which section 424(a) applies, with respect to the share so transferred; and

(3)no amount other than the price paid under the option shall be considered as received by any of such corporations for the share so transferred.

(b)If the transfer of a share of stock to an individual pursuant to his exercise of an option would otherwise meet the requirements of section 422(a) or 423(a) except that there is a failure to meet any of the holding period requirements of section 422(a)(1) or 423(a)(1), then any increase in the income of such individual or deduction from the income of his employer corporation for the taxable year in which such exercise occurred attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or of such employer corporation in which such disposition occurred. No amount shall be required to be deducted and withheld under chapter 24 with respect to any increase in income attributable to a disposition described in the preceding sentence.

(c)(1)If an option to which this part applies is exercised after the death of the employee by the estate of the decedent, or by a person who acquired the right to exercise such option by bequest or inheritance or by reason of the death of the decedent, the provisions of subsection (a) shall apply to the same extent as if the option had been exercised by the decedent, except that—

(A)the holding period and employment requirements of section 422(a) and 423(a) shall not apply, and

(B)any transfer by the estate of stock acquired shall be considered a disposition of such stock for purposes of section 423(c).

(2)If an amount is required to be included under section 423(c) in gross income of the estate of the deceased employee or of a person described in paragraph (1), there shall be allowed to the estate or such person a deduction with respect to the estate tax attributable to the inclusion in the taxable estate of the deceased employee of the net value for estate tax purposes of the option. For this purpose, the deduction shall be determined under section 691(c) as if the option acquired from the deceased employee were an item of gross income in respect of the decedent under section 691 and as if the amount includible in gross income under section 423(c) were an amount included in gross income under section 691 in respect of such item of gross income.

(3)In the case of a share of stock acquired by the exercise of an option to which paragraph (1) applies—

(A)the basis of such share shall include so much of the basis of the option as is attributable to such share; except that the basis of such share shall be reduced by the excess (if any) of (i) the amount which would have been includible in gross income under section 423(c) if the employee had exercised the option on the date of his death and had held the share acquired pursuant to such exercise at the time of his death, over (ii) the amount which is includible in gross income under such section; and

(B)the last sentence of section 423(c) shall apply only to the extent that the amount includible in gross income under such section exceeds so much of the basis of the option as is attributable to such share.

(d)If—

(1)a share of stock is transferred to an eligible person (as defined in section 1043(b)(1)) pursuant to such person’s exercise of an option to which this part applies, and

(2)such share is disposed of by such person pursuant to a certificate of divestiture (as defined in section 1043(b)(2)),

Notes & Related Subsidiaries

Editorial Notes

Amendments

2004—Subsec. (b). Pub. L. 108–357, § 251(b), inserted at end “No amount shall be required to be deducted and withheld under chapter 24 with respect to any increase in income attributable to a disposition described in the preceding sentence.” Subsec. (d). Pub. L. 108–357, § 905(a), added subsec. (d). 1990—Subsec. (a). Pub. L. 101–508, § 11801(c)(9)(B)(i)(I), substituted “422(a) or 423(a)” for “422(a), 422A(a), 423(a), or 424(a)” in introductory provisions. Subsec. (a)(1). Pub. L. 101–508, § 11801(c)(9)(B)(i)(II), struck out “except as provided in section 422(c)(1),” before “no income”. Subsec. (a)(2). Pub. L. 101–508, § 11801(c)(9)(B)(i)(III), substituted “424(a)” for “425(a)”. Subsec. (b). Pub. L. 101–508, § 11801(c)(9)(B)(ii), substituted “422(a) or 423(a)” for “422(a), 422A(a), 423(a), or 424(a)” and “422(a)(1) or 423(a)(1),” for “422(a)(1), 422A(a)(1), 423(a)(1), or 424(a)(1),”. Subsec. (c)(1)(A). Pub. L. 101–508, § 11801(c)(9)(B)(iii)(I), substituted “422(a) and 423(a)” for “422(a), 422A(a), 423(a), and 424(a)”. Subsec. (c)(1)(B). Pub. L. 101–508, § 11801(c)(9)(B)(iii)(II), substituted “section 423(c)” for “section 423(c) and 424(c)(1)”. Subsec. (c)(2), (3)(A). Pub. L. 101–508, § 11801(c)(9)(B)(iii)(III), substituted “423(c)” for “422(c)(1), 423(c), or 424(c)(1)” wherever appearing. Subsec. (c)(3)(B). Pub. L. 101–508, § 11801(c)(9)(B)(iii)(IV), (V), substituted “section 423(c)” for “section 422(c)(1), 423(c), and 424(c)(1)” and “such section” for “such sections”. 1981—Subsecs. (a), (b), (c)(1)(A). Pub. L. 97–34 inserted references to section 422A(a) in subsecs. (a), (b), and (c)(1)(A) and to section 422A(a)(1) in subsec. (b). 1964—Pub. L. 88–272 amended section generally, and among other changes, inserted provisions relating to the effect of a qualifying transfer, and to the basis of shares acquired when an option is exercised by an estate, and omitted provisions relating to treatment of restricted stock options, a special rule where option price was between 85 percent and 95 percent of value of stock, acquisition of new stock, definitions, modification, extension, or renewal of option, and corporate reorganizations, liquidations, etc. See sections 421 to 425 of this title. 1958—Subsec. (a). Pub. L. 85–866, § 25, inserted sentence authorizing substitution of “grantor corporation” or “corporation issuing or assuming a stock option in a transaction to which subsection (g) is applicable” for “employer corporation”. Subsec. (d)(6)(C). Pub. L. 85–320 added subpar. (C). Subsec. (d)(1)(A)(ii). Pub. L. 85–866, § 26(a)(1), substituted “in the case of a variable price option” for “in case the purchase price of the stock under the option is fixed or determinable under a formula in which the only variable is the value of the stock at any time during a period of 6 months which includes the time the option is exercised” and inserted “fair” before “market value”. Subsec. (d)(7). Pub. L. 85–866, § 26(a)(2), added par. (7).

Statutory Notes and Related Subsidiaries

Effective Date

of 2004 Amendment Pub. L. 108–357, title II, § 251(d), Oct. 22, 2004, 118 Stat. 1459, provided that: “The

Amendments

made by this section [amending this section, section 423, 3121, 3231, and 3306 of this title, and section 409 of Title 42, The Public Health and Welfare] shall apply to stock acquired pursuant to options exercised after the date of the enactment of this Act [Oct. 22, 2004].” Pub. L. 108–357, title VIII, § 905(b), Oct. 22, 2004, 118 Stat. 1653, provided that: “The amendment made by this section [amending this section] shall apply to sales after the date of the enactment of this Act [Oct. 22, 2004].”

Effective Date

of 1981 AmendmentAmendment by Pub. L. 97–34 applicable with respect to options granted on or after Jan. 1, 1976, and exercised on or after Jan. 1, 1981, or outstanding on Jan. 1, 1981, or granted on or after Jan. 1, 1976, and outstanding Aug. 13, 1981, see section 251(c) of Pub. L. 97–34, set out as an

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note under section 422 of this title.

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of 1964 Amendment Pub. L. 88–272, title II, § 221(e), Feb. 26, 1964, 78 Stat. 75, as amended by Pub. L. 99–514, § 2, Oct. 22, 1986, 100 Stat. 2095, provided that: “(1) Except as provided in paragraphs (2) and (3), the

Amendments

made by this section [enacting sections 422 to 425 and 6039, amending this section, section 402, 691, 6652, 6678, and the analysis preceding section 401 and 6031, and renumbering section 3039 as 3040 of this title] shall apply to taxable years ending after December 31, 1963. “(2) The

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made by paragraphs (1) and (3) of subsection (b) [enacting section 3039, renumbering former section 3039 as 3040, and amending section 6678 of this title] and paragraph (2) of section 6652(a) of the Internal Revenue Code of 1986 [formerly I.R.C. 1954] (as amended by paragraph (2) of subsection (b)), shall apply to stock transferred pursuant to options exercised on or after

January 1, 1964. “(3) In the case of an option granted after

December 31, 1963, and before

January 1, 1965—“(A) paragraphs (1) and (2) of section 422(b) of the Internal Revenue Code of 1986 (as added by subsection (a)), shall not apply, and “(B) paragraph (1) of section 425(h) of such Code (as added by subsection (a)), shall not apply to any change in the terms of such option made before

January 1, 1965, to permit such option to qualify under paragraphs (3), (4), and (5) of such section 422(b).”

Effective Date

of 1958 AmendmentAmendment by section 25 of Pub. L. 85–866 applicable to taxable years beginning after Dec. 31, 1953, and ending after Aug. 16, 1954, see section 1(c)(1) of Pub. L. 85–866, set out as a note under section 165 of this title. Pub. L. 85–866, title I, § 26(b), Sept. 2, 1958, 72 Stat. 1624, provided that: “The

Amendments

made by subsection (a) [amending this section] shall apply with respect to taxable years ending after September 30, 1958.” Pub. L. 85–320, § 3, Feb. 11, 1958, 72 Stat. 5, provided that: “The

Amendments

made by this Act [amending this section and section 1014 of this title] shall apply with respect to taxable years ending after December 31, 1956, but only in the case of employees dying after such date.”

Savings Provision

For provisions that nothing in amendment by Pub. L. 101–508 be construed to affect treatment of certain transactions occurring, property acquired, or items of income, loss, deduction, or credit taken into account prior to Nov. 5, 1990, for purposes of determining liability for tax for periods ending after Nov. 5, 1990, see section 11821(b) of Pub. L. 101–508, set out as a note under section 45K of this title.

§421 General rules

Summary

Title 26, §421

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