
From the U.S. Code Online via GPO Access
[wais.access.gpo.gov]
[Laws in effect as of January 2, 2001]
[Document not affected by Public Laws enacted between
  January 2, 2001 and January 28, 2002]
[CITE: 26USC421]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                        Subtitle A--Income Taxes
 
                  CHAPTER 1--NORMAL TAXES AND SURTAXES
 
                Subchapter D--Deferred Compensation, Etc.
 
                     PART II--CERTAIN STOCK OPTIONS
 
Sec. 421. General rules


(a) Effect of qualifying transfer

    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) Effect of disqualifying disposition

    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.

(c) Exercise by estate

                           (1) In general

        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 
        sections 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) Deduction for estate tax

        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) Basis of shares acquired

        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.

(Aug. 16, 1954, ch. 736, 68A Stat. 142; Pub. L. 85-320, Sec. 1, Feb. 11, 
1958, 72 Stat. 4; Pub. L. 85-866, title I, Secs. 25, 26(a), Sept. 2, 
1958, 72 Stat. 1623, 1624; Pub. L. 88-272, title II, Sec. 221(a), Feb. 
26, 1964, 78 Stat. 63; Pub. L. 97-34, title II, Sec. 251(b)(1), Aug. 13, 
1981, 95 Stat. 259; Pub. L. 101-508, title XI, Sec. 11801(c)(9)(B), Nov. 
5, 1990, 104 Stat. 1388-524.)


                               Amendments

    1990--Subsec. (a). Pub. L. 101-508, Sec. 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, Sec. 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, Sec. 11801(c)(9)(B)(i)(III), 
substituted ``424(a)'' for ``425(a)''.
    Subsec. (b). Pub. L. 101-508, Sec. 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, Sec. 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, Sec. 11801(c)(9)(B)(iii)(II), 
substituted ``section 423(c)'' for ``sections 423(c) and 424(c)(1)''.
    Subsec. (c)(2), (3)(A). Pub. L. 101-508, 
Sec. 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, Sec. 11801(c)(9)(B)(iii)(IV), 
(V), substituted ``section 423(c)'' for ``sections 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, Sec. 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, Sec. 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, Sec. 26(a)(2), added par. (7).


                    Effective Date of 1981 Amendment

    Amendment 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 of 1964 Amendment

    Section 221(e) of Pub. L. 88-272, as amended by Pub. L. 99-514, 
Sec. 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, sections 402, 691, 6652, 6678, and the analysis preceding 
sections 401 and 6031, and renumbering section 3039 as 3040 of this 
title] shall apply to taxable years ending after December 31, 1963.
    ``(2) The amendments 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 Amendments

    Amendment 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.
    Section 26(b) of Pub. L. 85-866 provided that: ``The amendments made 
by subsection (a) [amending this section] shall apply with respect to 
taxable years ending after September 30, 1958.''
    Section 3 of Pub. L. 85-320 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 29 of this 
title.

                  Section Referred to in Other Sections

    This section is referred to in sections 56, 83, 422, 423, 691 of 
this title.
