IRS Puts Out Final Stock Option Grant Rule

November 17, 2009 ( – U.S. Treasury department officials adopted some of the changes suggested by the public for rules governing the tax status of stock granted via options as part of an employee stock purchase plan (ESPP) before releasing a final rule Tuesday.

An Internal Revenue Service (IRS) news release said the final rule includes amendments to the tax code under sections 421, 422, 423 and 424. The new regulation went into effect Tuesday, but won’t apply until January 1, 2010.

Tuesday’s announcement follows a July 2008 release of a proposed rule and a January 2009 public hearing on the matter. The tax agency said it received electronic and written public comments after the hearing that were taken into account when formulating the new final version.

According to the final rule, if a share of stock is transferred to an individual pursuant to the exercise of a statutory option under section 421, 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.

Meanwhile, 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:

  • 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
  • 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.


Further, the tax agency said that as provided in Sec.  1.423-2(a)(3) of the proposed regulations, Sec.  1.423-2(a)(4) of the 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).

The 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.

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 the final regulations.

The text of the final rule is available here.