26 U.S.C. § 422 — Incentive stock options
submitted 45 years ago by Pub. L. 97-34 to r/title-26-INTERNAL-REVENUE-CODE · 1,110 words · no verdicts yet
Special tax treatment applies to stock from an incentive stock option if sold late enough. The holder must also stay employed almost until exercising the option. To qualify, the option itself must meet strict rules on approval, timing, and price.
(a) In general
Section 421(a)'s favorable tax treatment applies to stock* transferred when someone exercises an "incentive stock option," but only if: (1) they don't sell the stock within 2 years of when the option was granted, or within 1 year of when they got the stock, and (2) from the day the option was granted until 3 months before they exercised it, they were continuously an employee* of the company that granted the option (or its parent, subsidiary, or a company that took over the option under section 424(a)).
(b) Incentive stock option
An "incentive stock option" is an option given to an employee, for reasons connected to their job, by their employer corporation* (or its parent or subsidiary), to buy stock in one of those corporations — but only if all of these are true: (1) the option comes from a written plan that states the total number of shares* available and which employees (or groups of employees) can get options, and the company's stockholders approve that plan within 12 months before or after it's adopted; (2) the option is granted within 10 years of when the plan was adopted or approved by stockholders, whichever is earlier; (3) the option cannot be exercised more than 10 years after it was granted; (4) the price to buy the stock is not less than the stock's fair market value on the day the option was granted; (5) the option cannot be transferred to anyone else, except by will or inheritance, and only the employee can exercise it during their lifetime; and (6) when the option is granted, the employee does not own more than 10% of the voting power of all stock classes of the employer (or its parent or subsidiary). An option does not count as an incentive stock option if its own terms say it won't be treated as one, or if the employee makes a special election under section 83(i) for the stock received.
(c) Special rules
(1) If an option would fail to qualify only because the company made a good-faith mistake about the stock's fair market value under (b)(4), the rule in (b)(4) is treated as satisfied anyway. The Secretary* can apply a similar rule for the $100,000 limit in (d).
(2) If someone sells stock they got from an incentive stock option too soon (within the periods in (a)(1)), and that sale would have produced a deductible loss if there'd been a loss, then the amount counted as the employee's income — and as the employer's deduction — can't be more than what the person actually got from the sale minus the stock's adjusted basis.
(3) If an insolvent person holding this stock has it transferred to a bankruptcy trustee, receiver, or similar fiduciary* — or transfers it for creditors' benefit during bankruptcy or a similar proceeding — that transfer does not count as a "disposition*" under (a)(1).
(4) An option still counts as an incentive stock option even if: (A) the employee can pay using company stock, (B) the employee gets other property when they exercise the option, or (C) the option has any condition that doesn't conflict with subsection (b). Part (B) only applies to non-cash property if section 83 applies to it.
(5) The 10%-ownership rule in (b)(6) doesn't apply if the option price is at least 110% of the stock's fair market value and the option can't be exercised more than 5 years after it was granted.
(6) For an employee who is disabled (as defined in section 22(e)(3)), the 3-month window in (a)(2) becomes 1 year instead.
(7) For this section, a stock's fair market value ignores any restriction on it, unless that restriction never expires.
(d) $100,000 per year limitation
(1) If the total fair market value of stock covered by incentive stock options that first become exercisable for someone in one calendar year — counting all plans from the employer and its parent/subsidiary corporations — is more than $100,000, the amount over $100,000 is treated as options that are not incentive stock options.
(2) Options are counted in the order they were granted, when figuring out which ones go over the limit.
(3) The stock's fair market value, for this $100,000 calculation, is measured as of when the option was granted.
Section 421(a) shall apply with respect to the transfer of a share of stock* to an individual pursuant to his exercise of an incentive stock option if—
no disposition* of such share is made by him within 2 years from the date of the granting of the option nor within 1 year after the transfer of such share to him, and
at all times during the period beginning on the date of the granting of the option and ending on the day 3 months before the date of such exercise, such individual was an employee* of either the corporation* granting such option, a parent or subsidiary corporation* of such corporation, or a corporation or a parent or subsidiary corporation of such corporation issuing or assuming a stock option in a transaction to which section 424(a) applies.
For purposes of this part, the term “incentive stock option” means an option granted to an individual for any reason connected with his employment by a corporation, if granted by the employer corporation or its parent or subsidiary corporation, to purchase stock of any of such corporations, but only if—
the option is granted pursuant to a plan which includes the aggregate number of shares* which may be issued under options and the employees (or class of employees) eligible to receive options, and which is approved by the stockholders of the granting corporation within 12 months before or after the date such plan is adopted;
such option is granted within 10 years from the date such plan is adopted, or the date such plan is approved by the stockholders, whichever is earlier;
such option by its terms is not exercisable after the expiration of 10 years from the date such option is granted;
the option price is not less than the fair market value of the stock at the time such option is granted;
such option by its terms is not transferable by such individual otherwise than by will or the laws of descent and distribution, and is exercisable, during his lifetime, only by him; and
such individual, at the time the option is granted, does not own stock possessing more than 10 percent of the total combined voting power of all classes of stock of the employer corporation or of its parent or subsidiary corporation.
Such term shall not include any option if (as of the time the option is granted) the terms of such option provide that it will not be treated as an incentive stock option. Such term shall not include any option if an election is made under section 83(i) with respect to the stock received in connection with the exercise of such option.
If a share of stock is transferred pursuant to the exercise by an individual of an option which would fail to qualify as an incentive stock option under subsection (b) because there was a failure in an attempt, made in good faith, to meet the requirement of subsection (b)(4), the requirement of subsection (b)(4) shall be considered to have been met. To the extent provided in regulations by the Secretary*, a similar rule shall apply for purposes of subsection (d).
If—
an individual who has acquired a share of stock by the exercise of an incentive stock option makes a disposition of such share within either of the periods described in subsection (a)(1), and
such disposition is a sale or exchange with respect to which a loss (if sustained) would be recognized to such individual,
then the amount which is includible in the gross income of such individual, and the amount which is deductible from the income of his employer corporation, as compensation attributable to the exercise of such option shall not exceed the excess (if any) of the amount realized on such sale or exchange over the adjusted basis of such share.
If an insolvent individual holds a share of stock acquired pursuant to his exercise of an incentive stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary* in any proceeding under title 11 or any other similar insolvency proceeding, neither such transfer, nor any other transfer of such share for the benefit of his creditors in such proceeding, shall constitute a disposition of such share for purposes of subsection (a)(1).
An option which meets the requirements of subsection (b) shall be treated as an incentive stock option even if—
the employee may pay for the stock with stock of the corporation granting the option,
the employee has a right to receive property at the time of exercise of the option, or
the option is subject to any condition not inconsistent with the provisions of subsection (b).
Subparagraph (B) shall apply to a transfer of property (other than cash) only if section 83 applies to the property so transferred.
Subsection (b)(6) shall not apply if at the time such option is granted the option price is at least 110 percent of the fair market value of the stock subject to the option and such option by its terms is not exercisable after the expiration of 5 years from the date such option is granted.
For purposes of subsection (a)(2), in the case of an employee who is disabled (within the meaning of section 22(e)(3)), the 3-month period of subsection (a)(2) shall be 1 year.
For purposes of this section, the fair market value of stock shall be determined without regard to any restriction other than a restriction which, by its terms, will never lapse.
To the extent that the aggregate fair market value of stock with respect to which incentive stock options (determined without regard to this subsection) are exercisable for the 1st time by any individual during any calendar year (under all plans of the individual’s employer corporation and its parent and subsidiary corporations) exceeds $100,000, such options shall be treated as options which are not incentive stock options.
Paragraph (1) shall be applied by taking options into account in the order in which they were granted.
For purposes of paragraph (1), the fair market value of any stock shall be determined as of the time the option with respect to such stock is granted.
Source credit: (Added Pub. L. 97–34, title II, § 251(a), Aug. 13, 1981, 95 Stat. 256, § 422A; amended Pub. L. 97–448, title I, § 102(j)(1)–(4), Jan. 12, 1983, 96 Stat. 2373; Pub. L. 98–369, div. A, title V, § 555(a)(1), div. B, title VI, § 2662(f)(1), July 18, 1984, 98 Stat. 897, 1159; Pub. L. 99–514, title III, § 321(a), (b), title XVIII, § 1847(b)(5), Oct. 22, 1986, 100 Stat. 2220, 2856; Pub. L. 100–647, title I, § 1003(d)(1)(A), (2), Nov. 10, 1988, 102 Stat. 3384; renumbered § 422 and amended Pub. L. 101–508, title XI, § 11801(c)(9)(A)(i), (C), Nov. 5, 1990, 104 Stat. 1388–524, 1388–525; Pub. L. 115–97, title I, § 13603(c)(1)(A), Dec. 22, 2017, 131 Stat. 2163.)
- 1981Enacted · Pub. L. 97-34 · 95 Stat. 256
- 1983Amended · Pub. L. 97-448 · 96 Stat. 2373
- 1984Amended · Pub. L. 98-369 · 98 Stat. 897, 1159
- 1986Amended · Pub. L. 99-514 · 100 Stat. 2220, 2856
- 1988Amended · Pub. L. 100-647 · 102 Stat. 3384
- 1990Amended · Pub. L. 101-508 · 104 Stat. 1388
- 2017Amended · Pub. L. 115-97 · 131 Stat. 2163
A history note hasn’t been published yet. The record shows enactment by Pub. L. 97-34 on 1981-08-13.
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