IRS Revenue Ruling
1988-21

Code Secs. 2511, 2512

<<FULL TEXT>>

26 CFR 25.2511-1; Transfers in general.
(Also Section 2512; 25.2512-1.)

Transfer of nonstatutory stock option. This ruling provides guidance on
the time that a completed gift occurs when a nonstatutory stock option is
transferred without consideration by the optionee to a family member.


REV. RUL. 98-21

ISSUE

When is the transfer of a nonstatutory stock option (i.e., a
compensatory stock option that is not subject to the provisions of section
421 of the Internal Revenue Code) by the optionee to a family member, for
no consideration, a completed gift under section 2511?


FACTS

A is employed by Company. Company has one class of stock. Company has a
stock option plan under which employees can be awarded nonstatutory stock
options to purchase shares of Company's stock. These stock options are not
traded on an established market. The shares acquired on the exercise of an
option are freely transferable, subject only to generally applicable
securities laws, and subject to no other restrictions or limitations.

Company grants to A, in consideration for services to be performed by
A, a nonstatutory stock option to purchase shares of Company common stock.
Company's stock option plan provides that the stock option is exercisable
by A only after A performs additional services.

All options granted under Company's stock option plan expire 10 years
from the grant date. The exercise price per share of A's option is the
fair market value of one share of Company's common stock on the grant
date. Company's stock option plan permits the transfer of nonstatutory
stock options to a member of an optionee's immediate family or to a trust
for the benefit of those individuals. The effect of such a transfer is
that the transferee (after the required service is completed and before
the option's expiration date) will determine whether and when to exercise
the stock option and will also be obligated to pay the exercise price.

Before A performs the additional services necessary to allow A's option
to be exercised, A transfers A's option to B, one of A's children, for no
consideration.


LAW AND ANALYSIS

Section 2501 imposes a tax on the transfer of property by gift by any
individual. The gift tax is not imposed upon the receipt of the property
by the donee, is not necessarily determined by the measure of enrichment
resulting to the donee from the transfer, and is not conditioned upon the
ability to identify the donee at the time of the transfer. The tax is a
primary and personal liability of the donor, is an excise upon the donor's
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(a) of the Gift Tax Regulations.

The gift tax applies to a transfer of property by way of gift, 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 25.2511-1(a). For this purpose, the term property is
used in its broadest and most comprehensive sense and reaches "every
species of right or interest protected by law and having an exchangeable
value." H.R. Rep. No. 708, 72d Cong., 1st Sess. 27 (1932); S. Rep. No.
665, 72d Cong., 1st Sess. 39, (1932); both reprinted in 1939-1 (Part 2)
C.B. 476, 524. Some rights, however, are not property. See e.g., Estate of
Howell v. Commissioner, 15 T.C. 224 (1950) (nonvested pension rights were
not property rights includible in gross estate under section 811(c) of the
1939 Code); Estate of Barr v. Commissioner, 40 T.C. 227 (1963) acq.,
1964-1 C.B. 4 (death benefits payable at discretion of board of directors
who usually but not always, agreed to payment, were in the nature of hope
or expectancy and not property rights includible in gross estate for
estate tax purposes).

Generally, a gift is complete when the donor has so parted with
dominion and control over the property as to leave the donor no power to
change its disposition, whether for the donor's own benefit or for the
benefit of another. Section 25.2511-2(b).

In Estate of Copley v. Commissioner, 15 T.C. 17 (1950), aff'd, 194 F.2d
364 (7th Cir. 1952), acq., 1965-2 C.B. 4, the petitioner entered into an
antenuptial agreement in which the petitioner promised to give the future
spouse a sum of money in consideration of the marriage and in lieu of all
the spouse's marital rights in the petitioner's property. The agreement
became legally enforceable under state law on the date of the marriage in
1931. The petitioner transferred part of the sum of money in 1936 and the
rest in 1944. The court concluded that a gift tax would have been due in
1931 if there had been a gift tax law in effect at that time.

In Rev. Rul. 79-384, 1979-2 C.B. 344, a parent promised to pay a child
$10,000 if the child graduated from college. Rev. Rul. 79-384 holds that
the parent made a gift on the day the child graduated from college, the
date when the parent's promise became enforceable and determinable in
value.

In Rev. Rul. 80-186, 1980-2 C.B. 280, a parent transferred to a child,
for nominal consideration, an option to purchase real property for a
specified period of time at a price below fair value. Rev. Rul. 80-186
holds that the transfer is a completed gift at the time the option is
transferred provided the option is binding and enforceable under state law
on the date of the transfer.

In the present case, Company grants to A a nonstatutory stock option
conditioned on the performance of additional services by A. If A fails to
perform the services, the option cannot be exercised. Therefore, before A
performs the services, the rights that A possesses in the stock option
have not acquired the character of enforceable property rights susceptible
of transfer for federal gift tax purposes. A can make a gift of the stock
option to B for federal gift tax purposes only after A has completed the
additional required services because only upon completion of the services
does the right to exercise the option become binding and enforceable. In
the event the option were to become exercisable in stages, each portion of
the option that becomes exercisable at a different time is treated as a
separate option for the purpose of applying this analysis. In the event
that B is a skip person (within the meaning of section 2613(a)), the
generation-skipping transfer tax would apply at the same time as the gift
tax. See Rev. Proc. 98-34, 1998-18, which sets forth a methodology to
value certain compensatory stock options for gift, estate, and
generation-skipping transfer tax purposes.


HOLDING

On the facts stated above, the transfer to a family member, for no
consideration, of a nonstatutory stock option, is a completed gift under
section 2511 on the later of (i) the transfer or (ii) the time when the
donee's right to exercise the option is no longer conditioned on the
performance of services by the transferor.


DRAFTING INFORMATION

The principal author of this revenue ruling is Robert B. Hanson of the
Office of Assistant Chief Counsel (Passthroughs and Special Industries).
For further information regarding this revenue ruling, contact Melissa C.
Liquerman on (202) 622-3120 (not a toll-free call).

<<END RULING>>

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