[Federal Register Volume 68, Number 127 (Wednesday, July 2, 2003)]
[Rules and Regulations]
[Pages 39453-39454]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-16786]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9067]
RIN 1545-BC21


Transfers of Compensatory Options

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains regulations that provide rules 
governing transfers of certain compensatory stock options (nonstatutory 
stock options). The regulations affect persons who have been granted 
nonstatutory stock options, as well as service recipients who may be 
entitled to deductions related to the options. The text of the 
temporary regulations also serves as the text of the proposed 
regulations on this subject in the Proposed Rules section in this issue 
of the Federal Register.

DATES: Effective Date: These regulations are effective July 2, 2003.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.83-7(d) and 1.83-7T(d).

FOR FURTHER INFORMATION CONTACT: Stephen Tackney (202) 622-6030 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    These regulations amend 26 CFR part 1. Section 83 of the Internal 
Revenue Code (Code) provides that if, in connection with the 
performance of services, property is transferred to any person other 
than the person for whom such services are performed, the excess of (1) 
the fair market value of the property (determined without regard to 
lapse restrictions) at the first time the rights of the person having 
the beneficial interest in such property are transferable or are not 
subject to a substantial risk of forfeiture, whichever occurs earlier, 
over (2) the amount (if any) paid for such property, is included in the 
gross income of the service provider in the first taxable year in which 
the rights of the person having the beneficial interest in such 
property are transferable or are not subject to a substantial risk of 
forfeiture.
    Section 83(e)(4) provides that section 83 does not apply to the 
transfer of property pursuant to the exercise of an option with a 
readily ascertainable fair market value at the date of grant.
    Section 83(e)(3) provides that section 83 does not apply to the 
transfer of an option without a readily ascertainable fair market 
value. Under Sec.  1.83-7(a), section 83 generally applies to the 
transfer of the property subject to the option at the time of exercise.
    Section 1.83-7(a) further provides that section 83 applies to the 
transfer of money or other property received upon the sale or 
disposition in an arm's length transaction of an option without a 
readily ascertainable fair market value at the time of grant.
    Recent transactions promoted by certain parties have raised issues 
concerning when a transfer of an option to a related person, typically 
a family member or an entity a substantial interest in which is owned 
by the option holder or family members, is an arm's length transaction. 
See Notice 2003-47. The determination of whether a transfer to a 
related person is an arm's length transaction requires scrutiny of the 
facts and circumstances surrounding the transfer. Furthermore, if 
conducted under the terms promoted, Treasury and the IRS believe these 
transfers will rarely constitute an arm's length transaction.

Explanation of Provisions

    The regulations provide that a sale or other disposition of a 
nonstatutory stock option to a related person will not be treated as a 
transaction that closes the application of section 83 with respect to 
the option. For these purposes, a person is related to the service 
provider if (I) the person and the service provider bear a relationship 
to each other that is specified in section 267(b) or 707(b)(1), subject 
to the modifications (i) that ``20 percent'' is used in place of ``50 
percent'' each place it appears in section 267(b) and section 707(b)(1) 
and (ii) that section 267(c)(4) is applied as if the family of an 
individual includes the spouse of any member of the family, or (II) the 
service provider and such person are engaged in trades or businesses 
under common control (within the meaning of section 52(a) and (b)); 
provided that a person is not related to the service provider if the 
person is the service recipient with respect to the option or the 
grantor of the option. The regulations do not alter the treatment of 
the sale or disposition of an option in an arm's length transaction 
with an unrelated person. In those circumstances, section 83 applies to 
the transfer of money or other property received in the exchange.

Special Analyses

    It has been determined that these regulations are not a significant 
regulatory action as defined in Executive Order 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because these regulations do 
not impose a collection of information on small entities, the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 
Pursuant to section 7805(f) of the Code, these regulations are being 
submitted to the Chief Counsel for Advocacy of the Small

[[Page 39454]]

Business Administration for comment on its impact on small business.

Drafting Information

    The principal author of these temporary regulations is Stephen 
Tackney of the Office of Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities). However, other personnel from the IRS 
and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
1. The authority citation for part 1 continues to read in part as 
follows:

    Authority: 26 U.S.C. 7805 * * *.


0
2. Section 1.83-7 is amended by adding paragraph (d) to read as 
follows:


Sec.  1.83-7  Taxation of nonqualified stock options.

* * * * *
    (d) Effective dates. This section applies for periods before July 
2, 2003. For periods on or after July 2, 2003, see Sec.  1.83-7T.

0
3. Section 1.83-7T is added to read as follows:


Sec.  1.83-7T  Taxation of nonqualified stock options (Temporary).

    (a) In general. If there is granted to an employee or independent 
contractor (or beneficiary thereof) in connection with the performance 
of services, an option to which section 421 (relating generally to 
certain qualified and other options) does not apply, section 83(a) 
shall apply to such grant if the option has a readily ascertainable 
fair market value (determined in accordance with paragraph (b) of this 
section) at the time the option is granted. The person who performed 
such services realizes compensation upon such grant at the time and in 
the amount determined under section 83(a). If section 83(a) does not 
apply to the grant of such an option because the option does not have a 
readily ascertainable fair market value at the time of grant, sections 
83(a) and 83(b) shall apply at the time the option is exercised or 
otherwise disposed of, even though the fair market value of such option 
may have become readily ascertainable before such time. If the option 
is exercised, sections 83(a) and 83(b) apply to the transfer of 
property pursuant to such exercise, and the employee or independent 
contractor realizes compensation upon such transfer at the time and in 
the amount determined under section 83(a) or 83(b). If the option is 
sold or otherwise disposed of in an arm's length transaction, sections 
83(a) and 83(b) apply to the transfer of money or other property 
received in the same manner as sections 83(a) and 83(b) would have 
applied to the transfer of property pursuant to an exercise of the 
option. The preceding sentence does not apply to a sale or other 
disposition of the option to a person related to the service provider 
that occurs on or after July 2, 2003. For this purpose, a person is 
related to the service provider if--
    (1) The person and the service provider bear a relationship to each 
other that is specified in section 267(b) or 707(b)(1), subject to the 
modifications that the language ``20 percent'' is used instead of ``50 
percent'' each place it appears in sections 267(b) and 707(b)(1), and 
section 267(c)(4) is applied as if the family of an individual includes 
the spouse of any member of the family; or
    (2) The person and the service provider are engaged in trades or 
businesses under common control (within the meaning of section 52(a) 
and (b)); provided that a person is not related to the service provider 
if the person is the service recipient with respect to the option or 
the grantor of the option.
    (b) and (c) For further guidance, see Sec.  1.83-7(b) and (c).
    (d) Effective dates. This section applies on or after July 2, 2003. 
For dates before July 2, 2003 see Sec.  1.83-7.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: June 26, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-16786 Filed 7-1-03; 8:45 am]
BILLING CODE 4830-01-U