
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: 26USC424]

 
                     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. 424. Definitions and special rules


(a) Corporate reorganizations, liquidations, etc.

    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.

For purposes of this subsection, the parent-subsidiary relationship 
shall be determined at the time of any such transaction under this 
subsection.

(b) Acquisition of new stock

    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) Disposition

                           (1) In general

        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 
        request 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) Joint tenancy

        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) Special rule where incentive stock is acquired through 
                     use of other statutory option stock

        (A) Nonrecognition sections not to apply

            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,

        then no section referred to in subparagraph (B) of paragraph (1) 
        shall apply to such transfer.

        (B) Statutory option stock

            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) Transfers between spouses or incident to divorce

        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) Attribution of stock ownership

    For purposes of this part, in applying the percentage limitations of 
sections 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) Parent corporation

    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) Subsidiary corporation

    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) Special rule for applying subsections (e) and (f)

    In applying subsections (e) and (f) for purposes of section \1\ 
422(a)(2) and 423(a)(2), there shall be substituted for the term 
``employer corporation'' wherever it appears in subsection (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.
---------------------------------------------------------------------------
    \1\ So in original. Probably should be ``sections''.
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(h) Modification, extension, or renewal of option

                           (1) In general

        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) Special rule for section 423 options

        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) Definition of modification

        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) Stockholder approval

    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) Cross references

            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.

(Added Pub. L. 88-272, title II, Sec. 221(a), Feb. 26, 1964, 78 Stat. 
71, Sec. 425; amended Pub. L. 97-34, title II, Sec. 251(b)(2)-(4), Aug. 
13, 1981, 95 Stat. 259; Pub. L. 97-448, title I, Sec. 102(j)(5), (6), 
Jan. 12, 1983, 96 Stat. 2373; Pub. L. 98-369, div. A, title V, 
Sec. 555(b), July 18, 1984, 98 Stat. 898; Pub. L. 100-647, title I, 
Sec. 1018(l)(1), (2), Nov. 10, 1988, 102 Stat. 3584; Pub. L. 101-239, 
title VII, Sec. 7811(m)(6), Dec. 19, 1989, 103 Stat. 2412; renumbered 
Sec. 424 and amended Pub. L. 101-508, title XI, Sec. 11801(c)(9)(A)(i), 
(F), Nov. 5, 1990, 104 Stat. 1388-524, 1388-525; Pub. L. 104-188, title 
I, Sec. 1702(h)(13), Aug. 20, 1996, 110 Stat. 1874.)


                            Prior Provisions

    A prior section 424, added Pub. L. 88-272, title II, Sec. 221(a), 
Feb. 26, 1964, 78 Stat. 69; amended Pub. L. 94-455, title VI, 
Sec. 603(c), title XIV, Sec. 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, Sec. 11801(a)(21), Nov. 5, 1990, 104 Stat. 1388-
521. For savings provisions, see section 11821(b) of Pub. L. 101-508, 
set out as a note under section 29 of this title.


                               Amendments

    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, Sec. 11801(c)(9)(A)(i), renumbered section 
425 of this title as this section.
    Subsec. (a). Pub. L. 101-508, Sec. 11801(c)(9)(F)(i), substituted 
``424(a)'' for ``425(a)''.
    Subsec. (c)(3)(A)(ii). Pub. L. 101-508, Sec. 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, Sec. 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, Sec. 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, Sec. 11801(c)(9)(F)(v)(I), added 
par. (2) and struck out former par. (2) which related to special rules 
for sections 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, Sec. 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, Sec. 11801(c)(9)(F)(v)(II), 
substituted ``section 423(b)(9)'' for ``sections 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, Sec. 1018(l)(2), see 1988 Amendment note below.
    1988--Subsec. (c)(1). Pub. L. 100-647, Sec. 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, Sec. 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, Sec. 102(j)(6)(B), substituted 
``paragraphs (2) and (3)'' for ``paragraph (2)''.
    Subsec. (c)(3). Pub. L. 97-448, Sec. 102(j)(6)(A), added par. (3).
    Subsec. (j). Pub. L. 97-448, Sec. 102(j)(5), inserted reference to 
an incentive stock option.
    1981--Subsec. (d). Pub. L. 97-34, Sec. 251(b)(2), inserted reference 
to section 422A(b)(6).
    Subsec. (g). Pub. L. 97-34, Sec. 251(b)(3), inserted reference to 
section 422A(a)(2).
    Subsec. (h)(3)(B). Pub. L. 97-34, Sec. 251(b)(4), inserted reference 
to section 422A(b)(5).


                    Effective Date of 1996 Amendment

    Amendment 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 Amendment

    Amendment 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 Amendment

    Amendment 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

    Section 555(c)(3) of Pub. L. 98-369, as amended by Pub. L. 99-514, 
title XVIII, Sec. 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

    Section 102(j)(6) of Pub. L. 97-448 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 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

    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 29 of this 
title.

                  Section Referred to in Other Sections

    This section is referred to in sections 402, 421, 422, 423 of this 
title.
