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Thursday, April 25, 2024
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GiftLaw Note:
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PRIVATE RULING 9616035
DATE: January 23, 1996
This replies to your ruling request submitted on behalf of Taxpayer, concerning the application of section 83 and the gift and estate tax provisions 2 of the Internal Revenue Code, to the proposed transfer of certain stock options to one or more of Taxpayer's immediate family members.
Taxpayer is an employee of X. X has one class of common stock which is listed and principally traded. Taxpayer, together with all applicable family members within the meaning of section 2701(e)(2) of the Code and section 25.2701-1(b)(2) of the Income Tax Regulations, owns less than 50% of the stock of X. No applicable family member currently owns any stock of X and it is represented that X is not aware of any person who is the beneficial owner of more than 5% of X's outstanding common stock.
X has adopted a stock option plan (the "Plan") pursuant to which options to purchase shares of stock may be awarded to key employees, including officers of X and officers of each of its subsidiaries and affiliates. X intends to amend the Plan to permit limited transferability of options granted or to be granted. The class of permitted transferees will be limited to immediate family members, partnerships of which the only partners are members of the employee's immediate family, and trusts established solely for the benefit of such immediate family members.
Once the Plan is amended, Taxpayer intends to transfer the options to certain of his immediate family members. Each option will remain subject to the provisions of the Plan and therefore be exercisable as provided by the Plan and will be subject to such other rules as a committee, designated by the board of directors of X, determines. After the transfer, the family member will have sole responsibility for determining whether and when to exercise the options.
Section 83(a) of the Code provides that if, in connection with the performance of services, property is transferred to any person other than the person for whom the services are performed, the excess of the fair market value of the property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having a beneficial interest in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over the amount, if any, paid for the property, will be included in the gross income of the person who performed the services in the first taxable year in which the rights of the person having the beneficial interest in the property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable.
Pursuant to section 83(h) of the Code, there is allowed a deduction under section 162 of the Code, to the person for whom were performed the services in connection with which the property was transferred, an amount equal to the amount included under section 83 in the gross income of the person who performed the services. The deduction will be allowed for the taxable year of such person in which or with which ends the taxable year in which such amount is included in the gross income of the person who performed the services. Section 1.83-6(a)(3) of the Income Tax Regulations provides an exception to the rule of section 83(h) concerning what taxable year the service recipient is allowed the deduction. There, it is provided that, if the property is substantially vested upon transfer, the deduction will be allowed in accordance with the service recipient's method of accounting.
Under section 83(e)(3) of the Code, section 83 does not apply to the transfer of an option without a readily ascertainable fair market value.
Section 1.83-7(a) of the regulations provides, in part, that 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 the grant if the option has a readily ascertainable fair market value at the time the option is granted. If section 83(a) does not apply to the grant of the option because it does not have a readily ascertainable fair market value at the time of the grant, section 83 will apply at the time the option is exercised or otherwise disposed of, even though the fair market value of the option may have become readily ascertainable before such time. If the option is exercised, section 83(a) applies to the transfer of property pursuant to the exercise, and the employee or independent contractor realizes compensation upon the transfer at the time and in the amount determined under section 83(a). If the option is sold or otherwise disposed of in an arm's length transaction, section 83(a) applies to the transfer of money or other property received in the same manner as section 83 would apply to the transfer of property pursuant to the exercise of an option. See section 1.83-7(b) of the regulations for the tests to be applied in determining whether an option has a readily ascertainable fair market value.
In this case, the options do not have a readily ascertainable fair market value at the date of grant. Also, because the transfer of them to the family member will not be pursuant to an arm's length transaction, they will not be considered to be disposed of under section 1.83-7(a) of the regulations. Accordingly, section 83(a) of the Code will apply when the options are exercised and stock is transferred to the family member.
Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2511 provides that the tax imposed by section 2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Section 2512(b) provides that, where property is transferred for less than adequate and full consideration in money or money's worth, the amount by which the value of the property exceeds the value of the consideration is deemed a gift.
Section 25.2511-2(a) of the Gift Tax Regulations provides that the gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer, nor is it conditioned upon ability to identify the donee at the time of the transfer. On the contrary, the tax is a primary and personal liability of the donor, is an excise upon his act of making the transfer, is measured by the value of the property passing from the donor, and attaches regardless of the fact that the identity of the donee may not then be known or ascertainable.
Section 25.2511-2(b) provides that, as to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete. But if upon a transfer of property the donor reserves any power over its disposition, the gift may be wholly incomplete or may be partially complete and partially incomplete, depending upon all the facts in the particular case.
Section 25.2511-2(c) provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard.
Rev. Rul. 80-186, 1980-2 C.B. 280, holds that a transfer to a related party for nominal consideration, of an option to purchase real property for a specified period at a price below fair market value, is a completed gift on the date the option is transferred rather than the date the option is exercised, if under state law, the option is binding and enforceable on the date of transfer.
In the present case, Taxpayer proposes to transfer options on stock of X. The options will be transferred to immediate family members. The options must then be exercised, if at all, by the donee/family members during a period set forth under the Plan. Thus, after Taxpayer transfers the options, he will have no power or right to determine when the options are exercised.
Under the Plan, the exercise of the options may be accelerated if Taxpayer terminates his employment because of retirement, physical disability, or death. However, these are acts of independent significance and any affect such termination may have on the exercise of the options is only collateral or incidental to termination of employment. See, e.g., Rev. Rul. 84-130, 1984-2 C.B. 194. Accordingly, after transfer of the options, Taxpayer will have parted with dominion and control over the options and will have no power to change their disposition, for his benefit or for the benefit of another.
The amount of the gift will be the fair market value of the options transferred on the date of the gift. The fair market value of the options, for gift tax purposes, will be the fair market value determined under section 25.2512-1. Factors such as the possibility that the terms of the options may permit the options to be exercised without payment and the possibility that the committee may allow exercise of the options without payment, should be considered in valuing the options for gift tax purposes.
Section 2701 provides special valuation rules to determine the amount of a gift when an individual transfers an equity interest in a corporation or partnership to a member of the individual's family. In order for section 2701 to apply, the transferor or an applicable family member must, immediately after the transfer, hold an "applicable retained interest."
Section 25.2701-2(b)(1) provides that the term "applicable retained interest" means any equity interest in a corporation or partnership with respect to which there is either an "extraordinary payment right" or, in the case of a controlled entity, a "distribution right."
In the present case, Taxpayer proposes to transfer stock options granted to him by his employer, to family members. The options must be exercised within a specified term set forth in the option agreement. Until the options are exercised, the holder of the options has no right to receive dividends and no right to vote shares of the corporation. The holder has only the right to PURCHASE an equity interest (i.e., shares of stock). In purchasing the shares of stock, the holder would then obtain an equity interest in which he would have these rights. The holder of the options, thus, does not hold an equity interest in the corporation and a transfer of the options is not subject to section 2701.
Section 2703 provides that, for purposes of the estate, gift, and generation-skipping transfer taxes, the value of any property is determined without regard to 1) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right), or 2) any restriction on the right to sell or use such property.
Section 2703(b) provides an exception to the application of section 2703(a) in the case of a right or restriction, where the right or restriction is a bona fide business arrangement, the right or restriction is not a device to transfer the property to the natural objects of the transferor's bounty for less than adequate and full consideration in money or money's worth, and at the time the right or restriction is created, the terms of the right or restriction are comparable to similar arrangements entered into by persons in an arm's length transaction.
Section 25.2703-1(b)(3) provides that a right or restriction is considered to meet each of the three requirements described in section 2703(b) if more than 50 percent by value of the property subject to the right or restriction is owned directly or indirectly (within the meaning of section 25.2701-6) by individuals who are not members of the transferor's family. In order to meet this exception, the property owned by those individuals must be subject to the right or restriction to the same extent as the property owned by the transferor.
In the present case, the "property" whose value is at issue in section 2703 is the options themselves. The taxpayer is one of several employees of X to whom options have been issued and owns less than 50 percent of the options outstanding. All options outstanding are subject to the Plan.
Section 2033 provides for the inclusion in the gross estate of any property in which the decedent had an interest at the time of his death.
Section 2035(d) provides for the inclusion in the gross estate of property transferred within three years of the decedent's death, if the property would have been included under sections 2036, 2037, 2038, or 2042 if the decedent had retained the transferred property until death. Other transfers made within three years of death are not includible in the gross estate. Sections 2036, 2037, and 2038 provide for the inclusion in the gross estate of property of which the decedent has made a transfer and in which the decedent has either retained an interest in the property or a power over the property. Section 2042 provides for the inclusion in the gross estate of the proceeds of life insurance over which the decedent has retained any incidents of ownership.
Section 2041 provides that the gross estate shall include any property with respect to which the decedent has, at the time of his death, a general power of appointment or with respect to which the decedent has at any time released or exercised such power of appointment by a disposition which, had the property been owned by the decedent, such property would be includible in the decedent's gross estate under sections 2035 through 2038, inclusive. A general power of appointment is a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate, except where the decedent's power is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent.
In the present case, Taxpayer will transfer options that he has received as an employee of X. These options will be transferred to his family members in a completed gift. The family members may exercise the options and purchase stock at their discretion.
Taxpayer will retain no interest or reversion in the options or the stock upon exercise and has no right to alter, amend, or revoke the transfer of the options or stock. In addition, Taxpayer holds no general power of appointment over the options or the stock.
Based on the information submitted, we rule as follows:
1. The transfer of the stock options to the family members will not cause the recognition of taxable income or gain to Taxpayer.
2. If the family member subsequently exercises the stock options, Taxpayer (or, if Taxpayer is not then living, Taxpayer's estate) will be deemed to receive taxable compensation under section 83 of the Code and X will receive a corresponding deduction under section 162.
3. If the family member exercises stock options, the family member's basis in the stock so acquired will be its fair market value on the date of exercise which consists of the consideration paid by the family member and the income taxed to Taxpayer (or Taxpayer's estate) under section 83.
4. The transfer of the stock options to the family members will be a completed gift for purposes of section 2511.
5. The transfer of the stock options to the family members will not be subject to sections 2701 or 2703.
6. Once the gift is complete, neither the stock options nor the stock obtained upon exercise of the options, will be includible in Taxpayer's estate.
No opinion is expressed as to the federal tax consequences of the transaction described above under any other provisions of the Code.
This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
Sincerely yours,
CHARLES T. DELIEE
Assistant Chief, Branch 4
Office of the Associate
Chief Counsel
(Employee Benefits and Exempt Organizations)
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