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

Summary

Allow a company to replace or take over an employee stock option because of a merger, acquisition, reorganization, liquidation, or similar event only if the option’s immediate extra value after the change is no greater than before and the employee gets no new benefits. If stock is later received in certain corporate distributions tied to stock you got when you exercised an option (see sections 305, 354, 355, 356, 1036, and part of 1031), treat that stock as if you got it when you exercised the option. Treat a “disposition” generally as a sale, exchange, gift, or transfer of legal title, but not as transfers to an estate or by inheritance, not as certain tax-free exchanges (sections 354, 355, 356, 1036, and related 1031 items), and not as a mere pledge. Putting stock into joint ownership with survivorship is not a disposition when created, but ending that joint tenancy is a disposition (except for any ownership you actually gain). The rule also talks about transfers involving “statutory option stock” (stock from incentive stock options or employee stock purchase plans) and holding periods under sections 422(a)(1) or 423(a)(1). For family and entity ownership limits (sections 422(b)(6) and 423(b)(3)), count stock owned by close relatives and count entity-owned stock proportionally for its owners. Define “parent” and “subsidiary” corporations by an unbroken chain of 50 percent or more voting ownership at the time the option is granted. Changes to an option that add benefits are treated as a new grant. For options under section 423 that are changed, use the highest fair market value among the original grant date, the modification date, or any intervening modification date. “Modification” means a change that gives extra benefits, but not changes caused by an assumption under the merger rule, changes to meet section 423(b)(9), or speeding up exercise dates for options not immediately exercisable. If shareholder approval is needed to grant an option, treat the grant date as if that approval were not required. Reporting rules are in section 6039.

Title 26, §424

Internal Revenue Code — Source: USLM XML via OLRC

(a)For purposes of this part, the term “issuing or assuming a stock option in a transaction to which section 424(a) applies” means a substitution of a new option for the old option, or an assumption of the old option, by an employer corporation, or a parent or subsidiary of such corporation, by reason of a corporate merger, consolidation, acquisition of property or stock, separation, reorganization, or liquidation, if—

(1)the excess of the aggregate fair market value of the shares subject to the option immediately after the substitution or assumption over the aggregate option price of such shares is not more than the excess of the aggregate fair market value of all shares subject to the option immediately before such substitution or assumption over the aggregate option price of such shares, and

(2)the new option or the assumption of the old option does not give the employee additional benefits which he did not have under the old option.

(b)For purposes of this part, if stock is received by an individual in a distribution to which section 305, 354, 355, 356, or 1036 (or so much of section 1031 as relates to section 1036) applies, and such distribution was made with respect to stock transferred to him upon his exercise of the option, such stock shall be considered as having been transferred to him on his exercise of such option. A similar rule shall be applied in the case of a series of such distributions.

(c)(1)Except as provided in paragraphs (2), (3), and (4), for purposes of this part, the term “disposition” includes a sale, exchange, gift, or a transfer of legal title, but does not include—

(A)a transfer from a decedent to an estate or a transfer by bequest or inheritance;

(B)an exchange to which section 354, 355, 356, or 1036 (or so much of section 1031 as relates to section 1036) applies; or

(C)a mere pledge or hypothecation.

(2)The acquisition of a share of stock in the name of the employee and another jointly with the right of survivorship or a subsequent transfer of a share of stock into such joint ownership shall not be deemed a disposition, but a termination of such joint tenancy (except to the extent such employee acquires ownership of such stock) shall be treated as a disposition by him occurring at the time such joint tenancy is terminated.

(3)(A)If—

(i)there is a transfer of statutory option stock in connection with the exercise of any incentive stock option, and

(ii)the applicable holding period requirements (under section 422(a)(1) or 423(a)(1)) are not met before such transfer,

(B)For purpose of subparagraph (A), the term “statutory option stock” means any stock acquired through the exercise of an incentive stock option or an option granted under an employee stock purchase plan.

(4)In the case of any transfer described in subsection (a) of section 1041—

(A)such transfer shall not be treated as a disposition for purposes of this part, and

(B)the same tax treatment under this part with respect to the transferred property shall apply to the transferee as would have applied to the transferor.

(d)For purposes of this part, in applying the percentage limitations of section 422(b)(6) and 423(b)(3)—

(1)the individual with respect to whom such limitation is being determined shall be considered as owning the stock owned, directly or indirectly, by or for his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and

(2)stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust, shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries.

(e)For purposes of this part, the term “parent corporation” means any corporation (other than the employer corporation) in an unbroken chain of corporations ending with the employer corporation if, at the time of the granting of the option, each of the corporations other than the employer corporation owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

(f)For purposes of this part, the term “subsidiary corporation” means any corporation (other than the employer corporation) in an unbroken chain of corporations beginning with the employer corporation if, at the time of the granting of the option, each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

(g)In applying subsections (e) and (f) for purposes of section 422(a)(2) and 423(a)(2), there shall be substituted for the term “employer corporation” wherever it appears in subsections (e) and (f) the term “grantor corporation” or the term “corporation issuing or assuming a stock option in a transaction to which section 424(a) applies”, as the case may be.

(h)(1)For purposes of this part, if the terms of any option to purchase stock are modified, extended, or renewed, such modification, extension, or renewal shall be considered as the granting of a new option.

(2)In the case of the transfer of stock pursuant to the exercise of an option to which section 423 applies and which has been so modified, extended, or renewed, the fair market value of such stock at the time of the granting of the option shall be considered as whichever of the following is the highest—

(A)the fair market value of such stock on the date of the original granting of the option,

(B)the fair market value of such stock on the date of the making of such modification, extension, or renewal, or

(C)the fair market value of such stock at the time of the making of any intervening modification, extension, or renewal.

(3)The term “modification” means any change in the terms of the option which gives the employee additional benefits under the option, but such term shall not include a change in the terms of the option—

(A)attributable to the issuance or assumption of an option under subsection (a);

(B)to permit the option to qualify under section 423(b)(9); or

(C)in the case of an option not immediately exercisable in full, to accelerate the time at which the option may be exercised.

(i)For purposes of this part, if the grant of an option is subject to approval by stockholders, the date of grant of the option shall be determined as if the option had not been subject to such approval.

(j)For provisions requiring the reporting of certain acts with respect to a qualified stock option, an incentive stock option, options granted under employer stock purchase plans, or a restricted stock option, see section 6039.

Notes & Related Subsidiaries

Editorial Notes

Prior Provisions

A prior section 424, added Pub. L. 88–272, title II, § 221(a), Feb. 26, 1964, 78 Stat. 69; amended Pub. L. 94–455, title VI, § 603(c), title XIV, § 1402(b)(1)(F), (2), Oct. 4, 1976, 90 Stat. 1574, 1732, related to restricted stock options, prior to repeal by Pub. L. 101–508, title XI, § 11801(a)(21), Nov. 5, 1990, 104 Stat. 1388–521. For

Savings Provision

s, see section 11821(b) of Pub. L. 101–508, set out as a note under section 45K of this title.

Amendments

2018—Subsec. (g). Pub. L. 115–141 substituted “section 422(a)(2)” for “section 422(a)(2)”. 1996—Subsec. (c)(3)(B). Pub. L. 104–188 substituted “an incentive stock option or an option granted under an employee stock purchase plan” for “a qualified stock option, an incentive stock option, an option granted under an employee stock purchase plan, or a restricted stock option”. 1990—Pub. L. 101–508, § 11801(c)(9)(A)(i), renumbered section 425 of this title as this section. Subsec. (a). Pub. L. 101–508, § 11801(c)(9)(F)(i), substituted “424(a)” for “425(a)”. Subsec. (c)(3)(A)(ii). Pub. L. 101–508, § 11801(c)(9)(F)(ii), substituted “422(a)(1) or 423(a)(1)” for “422(a)(1), 422A(a)(1), 423(a)(1), or 424(a)(1)”. Subsec. (d). Pub. L. 101–508, § 11801(c)(9)(F)(iii), substituted “422(b)(6) and 423(b)(3)” for “422(b)(7), 422A(b)(6), 423(b)(3), and 424(b)(3)”. Subsec. (g). Pub. L. 101–508, § 11801(c)(9)(F)(iv), substituted “422(a)(2) and 423(a)(2)” for “422(a)(2), 422A(a)(2), 423(a)(2), and 424(a)(2)” and “424(a)” for “425(a)”. Subsec. (h)(2). Pub. L. 101–508, § 11801(c)(9)(F)(v)(I), added par. (2) and struck out former par. (2) which related to special rules for section 423 and 424 options and to an exception that such rules would not apply with respect to a modification, extension or renewal of a restricted stock option before Jan. 1, 1964, if the aggregate of the monthly fair market value for 12 consecutive months before date of modification, etc., divided by 12 is an amount less than 80% of the fair market value of such stock on the date of original granting or the date of modification, etc., whichever is higher. Subsec. (h)(3). Pub. L. 101–508, § 11801(c)(9)(F)(v)(III), struck out at end “If a restricted stock option is exercisable after the expiration of 10 years from the date such option is granted, subparagraph (B) shall not apply unless the terms of the option are also changed to make it not exercisable after the expiration of such period.” Subsec. (h)(3)(B). Pub. L. 101–508, § 11801(c)(9)(F)(v)(II), substituted “section 423(b)(9)” for “section 422(b)(6), 423(b)(9), and 424(b)(2)”. 1989—Subsec. (c)(1). Pub. L. 101–239 made technical correction to Pub. L. 100–647, § 1018(l)(2), see 1988 Amendment note below. 1988—Subsec. (c)(1). Pub. L. 100–647, § 1018(l)(2), as amended by Pub. L. 101–239, substituted “paragraphs (2), (3), and (4)” for “paragraphs (2) and (3)”. Subsec. (c)(4). Pub. L. 100–647, § 1018(l)(1), added par. (4). 1984—Subsec. (h)(3)(B). Pub. L. 98–369 struck out reference to section 422A(b)(5). 1983—Subsec. (c)(1). Pub. L. 97–448, § 102(j)(6)(B), substituted “paragraphs (2) and (3)” for “paragraph (2)”. Subsec. (c)(3). Pub. L. 97–448, § 102(j)(6)(A), added par. (3). Subsec. (j). Pub. L. 97–448, § 102(j)(5), inserted reference to an incentive stock option. 1981—Subsec. (d). Pub. L. 97–34, § 251(b)(2), inserted reference to section 422A(b)(6). Subsec. (g). Pub. L. 97–34, § 251(b)(3), inserted reference to section 422A(a)(2). Subsec. (h)(3)(B). Pub. L. 97–34, § 251(b)(4), inserted reference to section 422A(b)(5).

Statutory Notes and Related Subsidiaries

Effective Date

of 1996 AmendmentAmendment by Pub. L. 104–188 effective, except as otherwise expressly provided, as if included in the provision of the Revenue Reconciliation Act of 1990, Pub. L. 101–508, title XI, to which such amendment relates, see section 1702(i) of Pub. L. 104–188, set out as a note under section 38 of this title.

Effective Date

of 1989 AmendmentAmendment by Pub. L. 101–239 effective, except as otherwise provided, as if included in the provision of the Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100–647, to which such amendment relates, see section 7817 of Pub. L. 101–239, set out as a note under section 1 of this title.

Effective Date

of 1988 AmendmentAmendment by Pub. L. 100–647 effective, except as otherwise provided, as if included in the provision of the Tax Reform Act of 1986, Pub. L. 99–514, to which such amendment relates, see section 1019(a) of Pub. L. 100–647, set out as a note under section 1 of this title.

Effective Date

of 1984 Amendment Pub. L. 98–369, div. A, title V, § 555(c)(3),

July 18, 1984, 98 Stat. 898, as amended by Pub. L. 99–514, title XVIII, § 1855(a)(4), Oct. 22, 1986, 100 Stat. 2882, provided that: “The amendment made by subsection (b) [amending this section] shall apply with respect to modifications of options after

March 20, 1984.”

Effective Date

of 1983 Amendment Pub. L. 97–448, title I, § 102(j)(6), Jan. 12, 1983, 96 Stat. 2373, provided that the amendment made by that section is effective only with respect to transfers after March 15, 1982. Amendment by section 102(j)(5) of title I of Pub. L. 97–448 effective, except as otherwise provided, as if it had been included in the provision of the Economic Recovery Tax Act of 1981, Pub. L. 97–34, to which such amendment relates, see section 109 of Pub. L. 97–448, set out as a note under section 1 of this title.

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

Effective Date

note under section 422 of this title.

Effective Date

Section applicable to taxable years ending after Dec. 31, 1963, except in cases of options granted after Dec. 31, 1963, and before Jan. 1, 1965, in which case par. (1) of subsec. (h) shall not apply to any change in the terms of such option made before Jan. 1, 1965, to permit such option to qualify under pars. (3), (4), and (5) of section 422(b), see section 221(e) of Pub. L. 88–272, set out as an

Effective Date

of 1964 Amendment note under section 421 of this title.

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.

§424 Definitions and special rules

Summary

Title 26, §424

Notes & Related Subsidiaries

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Statutory Notes and Related Subsidiaries

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