IRS Revenue Procedure
2002-13

Code Sec. 280G



<<FULL TEXT>>

26 CFR 601.105: Examination of returns and claims for refund, credit, or
abatement; determination of correct tax liability.
(Also, Part I, 280G.)


REV. PROC. 2002-13

SECTION 1. PURPOSE

This revenue procedure provides guidance for valuing stock options,
including a safe harbor for valuing compensatory stock options for
purposes of sections 280G and 4999 of the Internal Revenue Code. The
Internal Revenue Service will treat the value of a compensatory stock
option determined in accordance with the requirements of this revenue
procedure as properly determined for purposes of sections 280G and 4999.


SECTION 2. BACKGROUND

Section 280G denies a deduction to a corporation for any excess
parachute payment. An excess parachute payment is defined in section
280G(b)(1) as an amount equal to the excess of any parachute payment over
the portion of the disqualified individual's base amount that is allocated
to such payment.

Section 280G(b)(2)(A) defines a parachute payment as any payment in the
nature of compensation to (or for the benefit of) a disqualified
individual if such payment is (i) contingent on a change in the ownership
of a corporation, the effective control of a corporation, or the ownership
of a substantial portion of the assets of a corporation (a change in
ownership or control), and (ii) the aggregate present value of the
payments in the nature of compensation which are contingent on such change
equals or exceeds an amount equal to 3 times the base amount. The term
parachute payment also includes any payment in the nature of compensation
to, or for the benefit of, a disqualified individual if the payment is
pursuant to an agreement that violates any generally enforced securities
laws or regulations.

A payment in the nature of compensation for purposes of section 280G
includes the transfer of an option (including an option to which section
421 applies), without regard to whether the option has a readily
ascertainable fair market value within the meaning of section 83. The
option is considered transferred not later than the time at which the
option becomes substantially vested (within the meaning of section
1.83-3(b) and (j)).

An individual's base amount is, in general, the individual's average
annualized includible compensation for the most recent 5 taxable years
ending before the date of the corporation's change in ownership or
control. For this purpose, the portion of the base amount allocated to a
parachute payment is the amount that bears the same ratio to the base
amount as the present value of the parachute payment bears to the
aggregate present value of all such payments to the same disqualified
individual.

Section 4999 imposes a 20-percent excise tax on the recipient of any
excess parachute payment, within the meaning of section 280G(b).

Rev. Proc. 98-34 (1998-1 C.B. 983) provides a methodology for valuation
of certain compensatory stock options for purposes of gift, estate, and
generation-skipping transfer taxes. The methodology described in Rev.
Proc. 98-34 is an option pricing model that takes into account factors
similar to those established by the Financial Accounting Standards Board
in Accounting for Stock-Based Compensation, Statement of Financial
Accounting Standards No. 123 (Fin. Accounting Standards Bd. 1995 (FAS
123)). This methodology applies only to the valuation of a nonpublicly
traded compensatory stock option for stock that, on the valuation date, is
publicly traded on an established securities market.


SECTION 3. STOCK OPTION VALUATION

.01 In general, a taxpayer may value a compensatory stock option using
any valuation method that is consistent with generally accepted accounting
principles (such as FAS 123) and that takes into account the factors
provided in section 1.280G-1, Q&A 13. A valuation using the valuation safe
harbor method provided in Section 4 is considered consistent with
generally accepted accounting principles for purposes of sections 280G and
4999 and this revenue procedure.

.02 If the stock option is one that could otherwise be valued under
Rev. Proc. 98-34 because the stock option is one that satisfies the
definition of "Compensatory Stock Option" under section 3 of Rev. Proc.
98-34, then, for purposes of sections 280G and 4999 and this revenue
procedure, the valuation is not considered consistent with generally
accepted accounting principles unless the valuation is made in accordance
with Rev. Proc. 98-34 or the valuation safe harbor method provided in
section 4 of this revenue procedure.


SECTION 4. VALUATION SAFE HARBOR

.01 IN GENERAL. The safe harbor valuation method provided by this
revenue procedure is based on the Black-Scholes model and takes into
account, as of the valuation date, the following factors: (1) the
volatility of the underlying stock, (2) the exercise price of the option,
(3) the value of the stock at the time of the valuation (the "spot
price"), and (4) the term of the option on the valuation date. The safe
harbor value of the option is calculated as the number of options
multiplied by the spot price of the stock multiplied by a valuation factor
determined using the factors described above and reflected in the table in
the Appendix. Other relevant factors, including risk-free rate of interest
and assumptions related to dividend yields are included in the table in
the Appendix. To determine the valuation factor, the taxpayer must
determine the volatility, spread, and option term factors, as described
below. To rely on this revenue procedure, assumptions made for purposes of
this revenue procedure and the determination of each factor must be
reasonable and consistent with assumptions made with respect to other
options valued in connection with the change in ownership or control.

.02 VOLATILITY. The taxpayer must determine whether the volatility of
the underlying stock is low, medium, or high. For this purpose, a low
volatility stock has an annual standard deviation of 30 percent or less. A
medium volatility stock has an annual standard deviation greater than 30
percent but less than 70 percent. A high volatility stock has an annual
standard deviation of 70 percent or greater. If the stock is publicly
traded on an established securities market (or otherwise), the expected
volatility of the underlying stock used for purposes of volatility under
this revenue procedure must be the volatility used for purposes of
complying with FAS 123 and disclosed in the most recent financial
statements of the corporation. If the stock is not publicly traded on an
established securities market or otherwise, but the stock is required to
be registered under the Securities Exchange Act of 1934, the volatility
for such stock is assumed to be the same as the volatility for a
comparable corporation that is publicly traded. For this purpose, whether
a corporation is considered comparable is determined by comparing relevant
characteristics such as industry, corporate size, earnings, market
capitalization, and debt-equity structure. If the stock is not publicly
traded and the corporation is not required to register under the
Securities Exchange Act of 1934, the taxpayer must assume medium
volatility. If the stock is not required to be registered under the
Securities Exchange Act of 1934, but the corporation voluntarily registers
its stock and its stock is publicly traded, the corporation must use the
volatility of the underlying stock.

.03 SPREAD BETWEEN EXERCISE PRICE AND SPOT PRICE. The factor based on
the spread between the exercise price and the spot price is calculated by
dividing the spot price by the exercise price and subtracting 1. If the
stock is not publicly traded, the determination of the spot price for this
purpose must be reasonable and consistent with the price, if any,
otherwise determined for the stock in connection with the transaction
giving rise to the change in control under section 280G(b)(2)(A). For
purposes of determining the factor based on spread between the exercise
price and the spot price under the table in the Appendix, the resulting
percentage may be rounded down to the next lowest interval. If this factor
exceeds 220%, this safe harbor valuation method cannot be used to value
the stock option.

.04 MAXIMUM TERM OF THE OPTION. The term of the option is the number of
full months between the date of the valuation and the latest date on which
the option will expire. For purposes of determining the term factor under
the table, the number of full months may be rounded down to the next
lowest six-month interval. If the term of the option exceeds 10 years (120
months), then this safe harbor valuation method cannot be used to value
the stock option.

.05 EXAMPLE. Corporation A undergoes a change in ownership or control
within the meaning of section 280G(b)(2). Contingent on the change in
ownership or control, Employee E, a disqualified individual, vests in 100
stock options in Corporation A stock, each of which has a remaining term
of 60 months after vesting. The volatility for Corporation A is 50%.
Therefore, the stock has medium volatility. At the time of the change in
ownership or control, the value of the stock is $24 (the spot price). The
exercise price under each of Employee E's options is $20. Therefore, the
factor based on spread is 20% (24/20 - 1). The value of the options under
the safe harbor valuation method described in section 4 of this revenue
procedure is $1,219.20 computed as follows: 100 options times the spot
price of $24 times 50.8% (the factor in the table in the Appendix for a
medium volatility stock with a 20% spread factor and a 60-month term).
Corporation A is permitted to use this value as the value of the payment
under section 1.280G-1, Q&A-13.


SECTION 5. REQUEST FOR COMMENTS

Comments are requested regarding safe harbor valuation method described
in this revenue procedure. All comments will be available for public
inspection and copying. Comments must be submitted by June 5, 2002.
Comments should be sent to CC:ITA:RU (Rev. Proc. 2002-13), room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC
20044. Comments may also be hand delivered between the hours of 8 a.m. and
5 p.m. to: CC:ITA:RU (Rev. Proc. 2002-13), Courier's Desk, Internal
Revenue Service, 1111 Constitution Avenue NW, Washington, DC. In the
alternative, e-mail your comments to:
Notice.Comments@irscounsel.treas.gov.


SECTION 6. EFFECTIVE DATE

This revenue procedure is effective April 26, 2002.


SECTION 7. DRAFTING INFORMATION

The principal author of this revenue procedure is Erinn Madden of the
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and Treasury
Department participated in its development. For further information
regarding this revenue procedure, contact Ms. Madden at (202) 622-6060
(not a toll-free call).


APPENDIX

Term
(months) 12 24 36 48 60
-------- -- -- -- -- --
Spread
Volatility Factor <*>
---------- ----------
Low 200% 67.3% 67.9% 68.4% 69.0% 69.5%
180% 65.0% 65.7% 66.4% 67.1% 67.7%
160% 62.4% 63.3% 64.1% 65.0% 65.8%
140% 59.4% 60.4% 61.5% 62.5% 63.5%
120% 55.8% 57.1% 58.4% 59.7% 60.9%
100% 51.5% 53.2% 54.8% 56.4% 57.9%
80% 46.3% 48.5% 50.6% 52.6% 54.3%
60% 40.0% 42.9% 45.6% 48.0% 50.1%
40% 32.3% 36.3% 39.7% 42.6% 45.2%
20% 23.3% 28.5% 32.7% 36.2% 39.3%
0% 13.6% 19.9% 24.7% 28.8% 32.3%
-20% 5.4% 11.2% 16.1% 20.4% 24.2%
-40% 0.9% 4.1% 7.9% 11.6% 15.2%
-60% 0.0% 0.6% 2.0% 4.0% 6.4%

72 84 96 108 120
-- -- -- --- ---
200% 69.9% 70.3% 70.7% 71.0% 71.2%
180% 68.3% 68.8% 69.3% 69.6% 69.9%
160% 66.5% 67.1% 67.7% 68.1% 68.5%
140% 64.4% 65.1% 65.8% 66.4% 66.9%
120% 62.0% 62.9% 63.7% 64.5% 65.1%
100% 59.1% 60.3% 61.3% 62.2% 63.0%
80% 55.9% 57.3% 58.5% 59.6% 60.5%
60% 52.0% 53.7% 55.2% 56.5% 57.6%
40% 47.4% 49.4% 51.2% 52.7% 54.1%
20% 41.9% 44.3% 46.4% 48.2% 49.9%
0% 35.4% 38.1% 40.5% 42.7% 44.7%
-20% 27.6% 30.6% 33.4% 35.9% 38.1%
-40% 18.5% 21.7% 24.6% 27.3% 29.9%
-60% 9.0% 11.6% 14.3% 16.8% 19.3%

12 24 36 48 60
-- -- -- -- --
Medium 200% 67.4% 68.6% 69.9% 71.1% 72.2%
180% 65.2% 66.7% 68.2% 69.6% 70.9%
160% 62.7% 64.5% 66.3% 68.0% 69.4%
140% 59.8% 62.0% 64.2% 66.1% 67.7%
120% 56.4% 59.2% 61.7% 63.9% 65.8%
100% 52.5% 55.9% 58.9% 61.5% 63.7%
80% 47.9% 52.2% 55.7% 58.7% 61.2%
60% 42.6% 47.8% 52.0% 55.4% 58.3%
40% 36.3% 42.7% 47.6% 51.6% 54.8%
20% 29.1% 36.8% 42.5% 47.0% 50.8%
0% 21.2% 30.0% 36.4% 41.6% 45.8%
-20% 13.0% 22.2% 29.2% 34.9% 39.7%
-40% 5.7% 13.8% 20.8% 26.8% 32.0%
-60% 1.2% 5.9% 11.4% 16.9% 22.1%

72 84 96 108 120
-- -- -- --- ---
200% 73.1% 73.9% 74.5% 75.0% 75.4%
180% 71.9% 72.8% 73.5% 74.1% 74.6%
160% 70.6% 71.6% 72.5% 73.2% 73.7%
140% 69.1% 70.3% 71.2% 72.0% 72.7%
120% 67.4% 68.8% 69.9% 70.8% 71.6%
100% 65.5% 67.0% 68.3% 69.4% 70.3%
80% 63.2% 65.0% 66.5% 67.7% 68.8%
60% 60.6% 62.7% 64.3% 65.8% 67.0%
40% 57.6% 59.9% 61.8% 63.5% 64.9%
20% 53.9% 56.5% 58.8% 60.7% 62.3%
0% 49.4% 52.4% 55.0% 57.2% 59.1%
-20% 43.7% 47.2% 50.2% 52.8% 55.0%
-40% 36.4% 40.4% 43.8% 46.8% 49.5%
-60% 26.7% 31.0% 34.8% 38.3% 41.4%

12 24 36 48 60
-- -- -- -- --
High 200% 68.1% 70.7% 73.1% 75.0% 76.6%
180% 66.1% 69.1% 71.7% 73.9% 75.6%
160% 63.8% 67.3% 70.3% 72.7% 74.6%
140% 61.3% 65.3% 68.6% 71.3% 73.4%
120% 58.3% 63.0% 66.8% 69.7% 72.1%
100% 55.0% 60.4% 64.6% 67.9% 70.6%
80% 51.1% 57.4% 62.2% 65.9% 68.8%
60% 46.6% 54.0% 59.4% 63.5% 66.8%
40% 41.4% 50.0% 56.1% 60.7% 64.4%
20% 35.4% 45.3% 52.1% 57.4% 61.5%
0% 28.5% 39.6% 47.4% 53.3% 57.9%
-20% 20.8% 32.9% 41.5% 48.1% 53.4%
-40% 12.7% 24.8% 34.0% 41.4% 47.3%
-60% 5.2% 15.2% 24.3% 32.1% 38.8%

72 84 96 108 120
-- -- -- --- ---
200% 77.8% 78.8% 79.5% 80.0% 80.4%
180% 77.0% 78.1% 78.9% 79.5% 79.9%
160% 76.1% 77.3% 78.2% 78.9% 79.4%
140% 75.1% 76.4% 77.4% 78.2% 78.8%
120% 73.9% 75.4% 76.6% 77.4% 78.1%
100% 72.6% 74.3% 75.6% 76.6% 77.3%
80% 71.1% 73.0% 74.4% 75.6% 76.5%
60% 69.4% 71.4% 73.1% 74.4% 75.4%
40% 67.3% 69.6% 71.5% 73.0% 74.2%
20% 64.8% 67.4% 69.6% 71.3% 72.7%
0% 61.6% 64.7% 67.1% 69.1% 70.8%
-20% 57.6% 61.1% 64.0% 66.4% 68.3%
-40% 52.2% 56.3% 59.7% 62.5% 64.8%
-60% 44.4% 49.1% 53.2% 56.6% 59.5%

----------
*/ Strike Price/Exercise Price -- 1 or (S/X-1)

<<END RULING>>


 

TO CONTACT
DON FITCH CPA

Phone Don Fitch CPA Toll Free at (877)CPA-Help or (877)272-4357 or on our Direct Line at (760)674-1722.