IRS Issues Comprehensive Proposed Rewrite of Regulations for Incentive Stock Options and Employee Stock Purchase Plans

In proposed regulations published June 9, 2003 (26 CFR Parts 1 and 14a, Reg 122917-02, June 9, 2003), the Internal Revenue Service proposed an update, reorganization, and elaboration of existing rules governing incentive stock options and employee stock purchase plans (ESPPs). The proposed regulations did not add any dramatic new changes in the regulations of these plans, but did answer of number of technical uncertainties about certain plan specifics. Among the more notable of the changes are:

• $100,000 limitation: Options first exercised during a calendar year pursuant to an acceleration clause do not affect the application of the $100,000 rule for options exercised prior to the acceleration provision.
• Definition of corporation: Corporations are now defined to include not just C corporations, but any entity choosing to be taxed as a corporation under federal income tax rules as well, including S corporations, foreign corporations, and limited liability corporations (LLCs).
• Definition of "option": The definition of an option is expanded to include warrants if the warrants meet other qualifications of the regulations.
• Definition of stock: Stock is defined to include capital stock of any class and with any combination of voting rights or no voting rights as well as special classes of stock authorized only to be issued to employees.
• Electronic forms allowed: Electronic forms to be used as well provided they meet regulatory requirements for such forms.
• Modification of options: The regulations would clarify that options whose terms are changed by certain corporate transactions would not be considered new grants.
• Shareholder approval: If a company has a subsidiary, and the subsidiary's employees get statutory options in the subsidiary under an approved plan, the parent must get new shareholder approval within 12 months only if it subsequently amends the plan so that the subsidiary's employees will now get options in the parent.

These regulations withdraw the 1984 proposed regulations under Code Sections 421, 422, 424, and 6039. The effective date of the new regulations is 180 days after the publication of the final regulations. The new regulations would apply to any option granted on or after that date; prior to this, companies can rely on the regulations as proposed for options granted June 9 or later. A more detailed description of the regulations is available on request to NCEO members.