THE NEW OPTIONS REGULATIONS - AN
OVERVIEW
Robert B. Webb III, Esq.
Introduction
SQUIRE, SANDERS
&
D E M P S E Y L .L .P.
An international
law firm with more
than 700 lawyers in
26 offices worldwide
Squire, Sanders & Dempsey L.L.P.
Representing clients
worldwide in matters
crossing 80 country borders
Speaking
50+ languages
Practicing in 150+
courts and jurisdictions
Representation of nearly
half of the Fortune 500
companies including 9
of the top 10 and 17
of the top 20
Squire, Sanders & Dempsey L.L.P.
Employee Benefits Capability
•designing and drafting complex defined benefit
and defined contribution plans
•cash balance plans
•supplemental executive retirement plans
•rabbi trusts
•expatriate benefits
•prohibited transaction exemptions
•Department of Labor and IRS plan audits
•CAP and VCR programs and COBRA issues.
Squire, Sanders & Dempsey L.L.P.
Stock Plan & Executive Compensation
Expertise
•Stock Option Programs
•Employee Stock Ownership Plans
•Stock Purchase Plans
•Deferred compensation Plans
•Phantom Stock Plans
•Management Buyout Expertise
Squire, Sanders & Dempsey L.L.P.
Key Services
•
Corporate, transactions and securities
•
Environmental
•
Intellectual property
•
Labor and employment
•
Litigation and international dispute
resolution
•
Project finance
•
Public finance
•
Real estate
•
Regulatory
•
Restructuring and bankruptcy
•
Tax
Squire, Sanders & Dempsey L.L.P.
Tyson’s Corner Office
•
Established in 2001
•
22 attorneys – experienced Virginia practitioners
•
Lawyers experienced in the formation,
capitalization, management, growth and
disposition of all types of companies.
•
Handle complex commercial lending and leasing,
creative financing structures, corporate control
and shareholder issues, M&A preparation,
securities offerings, and stock option and other
equity ownership plans.
•
Devote attention to protecting intellectual property,
training employers for employment law
compliance and structuring executive
compensation agreements.
•
Employment Law, HR Benefits and Labor law
expertise
Squire, Sanders & Dempsey L.L.P.
Washington DC Office
•
Established in 1971
•
Strong regulatory practice before all major federal
governmental agencies
•
Extensive experience in the government - lawyers come
from FCC, FERC, US Dept. of Justice, White House and
Congress
•
Work closely with international offices
•
Litigation lawyers with specialized experience in alternative
dispute resolution, white collar criminal defense, complex
business litigation and intellectual property litigation
•
Practice in international and off-shore corporate tax matters,
international investment fun and international trade and
tariff matters
•
Industry expertise in energy, aviation and
telecommunications
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - AN OVERVIEW
• August 3, 2004 – IRS Issued New “Final Regulations”
regarding stock options and IRC 423 Stock Purchase
Plans
• Available from IRS website at
http://www.irs.gov/pub/irs-regs/td9144.pdf or
• www.esop.us/irsoptionregulations.pdf
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS REGULATIONS –
What these regulations are not
• These are not related to option
expensing for financial accounting
• These regulations are not related to
employer payroll and FICA/FUTA
withholding obligations
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS •The Regulations address Sections 421, 422 and 423
of the Internal Revenue Code.
•IRC 421 – General provision which provides that
there is no taxable income upon exercise of a
“statutory stock option.”
•A “Statutory Stock Option is an option to purchase
stock of a corporation that is either (a) an incentive
stock option under Section 422 of the Code, or (b) the
right to purchase stock pursuant to a stock purchase
plan under Section 423 of the Code
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS •The Regulations reflect a comprehensive set of
regulations for statutory stock options – finalizing an
IRS regulatory project first begun with the 1984
publication of proposed regulations.
•In 2003 the IRS issued new proposed regulations
•The Regulation do not affect the tax treatment for
nonqualified stock options
•The Regulations do not change the Alternative
Minimum Tax treatment of gain upon exercise of an
incentive stock option
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS In large part, the Regulations reflect much of the
substance of the 1984 proposed regulations, but
attempt to provide greater clarity in certain areas.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS – Specific Points
Employment Relationship
•IRC 422 and 423 provide that Statutory
Stock Options may only be granted to
employees of the granting corporation, a
.
parent or subsidiary of the granting
corporation, or a corporation issuing or
assuming the option in a merger within the
scope of IRC 424.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS – Specific Points
Employment Relationship
The regulations provide that in the case of
an assumption or substitution under IRC
424(a), the period of during which options
.
may be granted includes the period up to 3
months after employment termination.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS – Specific Points
Employment Relationship
The regulations also provide, that in the case
of employees with a contractual or statutory
right to return (sick leave, family medical
.
leave, military leave) the period includes 3
months (or longer as in the case of Family
medical leave or military leave reemployment rights).
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS – Specific Points
Disqualifying Dispositions
•A disqualifying disposition occurs when an optionee
purchase and then disposes of stock before 2 years
from the date of grant or one year from exercise.
•The regulations clarify the calculation of these
. periods.
•Most notably – when options are “early exercised”
prior to vesting, if a disqualifying disposition occurs,
holding period is calculated from the date of exercise,
but ordinary income is calculated based upon the date
of vesting, not the date of exercise
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Shareholder Approval Requirements
•Statutory Stock Option Plans must be approved by
shareholders within 12 months before or after a plan
is adopted. The regulations do not vary this basic rule.
•The Regulations do clarify, that when a merger
occurs, an assumed plan must be approved, but that
this approval requirement is met if the merger is
approved by shareholder vote and the plan of merger
expressly describes the plan and provides that it will
be continued after the consolidation.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Maximum Aggregate Number of Shares
•The Code expressly requires that the shareholder
approval must include a maximum number (not
percentage or formula) of shares that may be issued
under the plan.
• The regulations clarify that this must be a specific
number for the statutory plan, not a global number for
both statutory and non-statutory options
•The regulations also clarify that this number may be
calculated as a “net” number – i.e. if netting is
permitted, only the net number counts against the
total.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Fair Market Value
•Statutory Options must be granted at Fair market
Value ( or a set percentage thereof in certain cases)
•The Regulations repeat the Code provisions that a
reasonable effort will suffice, but in reference to nonpublic corporations, refer to determination by “an
average of appraisals by qualified appraisers” – thus
suggesting that one appraisal may not be enough. The
IRS specifically commented that they were rejection
suggestions that a single appraisal should suffice.
•Minority/Discounts/Control Premiums may be used
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
$100,000 Limitation
•As to any individual, the number which qualify as
Incentive stock options is limited to $100,000 which
“first become exercisable at any time during the year.
•The Regulations clarify that this is calculated
throughout the year but applied in the order granted.
Thus options granted 5 years ago but which “vest” in
December will, “pre-empt” ISO status and use the
$100,000 limit ahead of options granted 1 year ago
but which vest in February.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
$100,000 Limitation
•If an option grant exceeds the limit, a corporation
may designate or “bifurcate” the grant by separate
certificate or designation in plan records.
•Absent such designation, any shares purchase are
first deemed exercised under the $100,000 limit, then
treated as Non-qualified options.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Substitution, Modification or Assumption
•In a statutory option is modified, extended or
renewed, that is generally treated as a new option
•A modification is any change which gives the
optionee additional benefits.
•Corporate Transactions such as mergers, stock
dividends, or similar are not treated as modifications
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Substitution, Modification or Assumption
•A change to an option to give a corporation the
discretion to provide an additional benefit upon
exercise is considered a modification.
•The exercise of discretion to grant that additional
benefit is also a modification.
•If the right to exercise discretion to pay a bonus,
provide a loan, or permit exercise with shares is in the
original plan, the exercise of that discretion is not a
modification. The exercise of discretion to pay taxes
is not a modification if reserved under the original
plan.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Substitution, Modification or Assumption
•A change which is offered but not accepted is not a
modification if the optionee must exercise it within 30
days or less (but a greater period is considered a
modification even if not taken).
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Mergers
•The Regulations confirm that in the case of a merger,
options previously granted under the plan are not
subject to a second shareholder approval requirement.
•The Regulations contains detailed provisions for
proper adjustment to terms in a merger to avoid the
transaction resulting in a “modification.”
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Effective Dates
•The Regulations are effective August 3, 2004
•Transition Rules Apply:
•For options granted before June 9, 2003, optionees
may rely upon either the 1984 Proposed Regulations,
the 2003 Proposed Regulations, or the Regulations
until January 1, 2006 or the first regularly scheduled
shareholder meeting after March 2, 2005.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS
REGULATIONS - – Specific Points
Effective Dates
•For options granted after June 9, 2003 until the
earlier of (a) January 1, 2006 or (b) the first regularly
scheduled shareholder meeting after March 2, 2005,
optionees may rely upon either the 2003 Proposed
Regulations, or the Regulations until January 1, 2006.
•Taxpayers must rely consistently and entirely
•After January 1, 2006, the Regulations apply in all
cases.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS REGULATIONS - –
Strategies for Corporations
•Review Plans for consistency and compliance (or
variance from the regulations.
•Consider new plans and suspension of old plans (no
new grants)
•In issues exist-consider advising optionees to
exercise during transition period to insure old rules
apply.
Squire, Sanders & Dempsey L.L.P.
THE NEW OPTIONS REGULATIONS - –
Strategies for Optionees
•Consider early exercise
Squire, Sanders & Dempsey L.L.P.
Post Event Archive
www.esop.us
(within 1-2 weeks)
Contact Info
Bob Webb
Squire, Sanders &
Dempsey L.L.P.
rwebb@ssd.co
+1 703.720.7855
Squire, Sanders & Dempsey L.L.P.