26 U.S.C. § 424 — Definitions and special rules

(a) Corporate reorganizations, etc. In this part of the tax code, "issuing or assuming a stock option in a transaction to which section 424(a) applies" means a company gives an employee a new option to replace an old one — or takes over the old one — because of a merger, consolidation, buying property or stock, a corporate split, reorganization, or liquidation. This only counts if: (1) the extra value the employee could gain right after the swap — the shares' market value minus the option price — is no more than the extra value they could have gained right before the swap; and (2) the new option doesn't give the employee any benefits beyond what the old option gave. Whether one company counts as a "parent" of another is judged at the time of that transaction. (b) Acquisition of new stock. If someone gets new stock through a distribution covered by section 305, 354, 355, 356, or 1036 (or the part of section 1031 that relates to 1036), and that distribution was paid on stock they got by exercising their option, the new stock is treated as if it came directly from exercising the option. The same rule applies again through a whole series of such distributions. (c) Disposition. (1) "Disposition" usually means selling, trading, gifting, or transferring legal title to the stock. It does NOT include: (A) stock passing from someone who died to their estate, or through a will or inheritance; (B) an exchange covered by section 354, 355, 356, or 1036 (or the related part of 1031); or (C) simply pledging the stock as loan collateral. (2) Putting stock into joint ownership with the employee and someone else, with right of survivorship, is not a "disposition" — and neither is later moving stock into that kind of joint ownership. But ending that joint tenancy counts as a disposition at the moment it ends, unless the employee ends up owning the stock outright. (3) If stock from one statutory option gets used as part of exercising an incentive stock option, and the required holding periods under section 422(a)(1) or 423(a)(1) haven't been met yet, the tax-free treatment described in (c)(1)(B) doesn't apply to that transfer. "Statutory option stock" means stock from exercising an incentive stock option or an employee-stock-purchase-plan option. (4) For a transfer between spouses or as part of a divorce, covered by section 1041(a): it does not count as a "disposition" here, and the person receiving the stock gets the same tax treatment the person who transferred it would have had. (d) Attribution of stock ownership. When applying the ownership-percentage limits in sections 422(b)(6) and 423(b)(3): a person is treated as owning stock that their siblings (full or half), spouse, parents, grandparents, children, or grandchildren own, directly or indirectly. And stock owned by a corporation, partnership, estate, or trust is treated as owned proportionally by its shareholders, partners, or beneficiaries. (e) Parent corporation. A "parent corporation" is any company besides the employer, in an unbroken chain of companies ending with the employer, where — at the time the option was granted — every company except the employer owns at least 50% of the voting power of the next company in the chain. (f) Subsidiary corporation. A "subsidiary corporation" is any company besides the employer, in an unbroken chain starting with the employer, where — at the time the option was granted — every company except the last one owns at least 50% of the voting power of the next company in the chain. (g) Special rule for (e) and (f). When applying subsections (e) and (f) for purposes of sections 422(a)(2) and 423(a)(2), swap in the term "grantor corporation" — or "corporation issuing or assuming a stock option in a transaction to which section 424(a) applies" — wherever "employer corporation" appears in (e) and (f), whichever term fits. (h) Modification, extension, or renewal of option. (1) If an option's terms get changed, extended, or renewed, that counts as granting a brand-new option. (2) For stock transferred through a section 423 option that was later modified, extended, or renewed, the stock's fair market value "at the time of granting" is whichever is highest of: (A) its value when the option was first granted; (B) its value when the modification, extension, or renewal happened; or (C) its value at any earlier modification, extension, or renewal along the way. (3) A "modification" is any change to the option's terms that gives the employee extra benefits. It does not include a change that: (A) comes from issuing or assuming an option under subsection (a); (B) is needed to qualify the option under section 423(b)(9); or (C) simply lets the employee exercise the option sooner, when it wasn't already fully exercisable. (i) Stockholder approval. If granting an option requires stockholder approval, the option's grant date is figured as if that approval requirement never applied. (j) Cross references. For the rules on reporting certain actions involving a qualified stock option, an incentive stock option, an employee-stock-purchase-plan option, or a restricted stock option, see section 6039.