Rev. Rul. 56-452

Advice has been requested whether the granting of an option under an employer-employee restricted stock option plan and the accrual of installments thereunder constitute the entry into an option agreement by the employee within the meaning of section 1091 of the Internal Revenue Code of 1954. Advice has also been requested whether an employee acquires stock within the meaning of section 1091 of the Code when he exercises his option by notifying the company or when the stock certificates are issued to him.

In accordance with the restricted stock option plan instituted by a corporation, key employees are granted from time to time the privilege of purchasing the company's common stock of no par value at the fair market value of the stock on the day the option is granted. The plan is administered by a committee made up of directors of the company, which determines which employees shall be granted options and which prescribes other regulatory terms and conditions. It is provided that the date on which the committee approves the grant shall be considered the date on which the option is granted and it is required that the employee be notified promptly of the committee's action. Each option and all rights and obligations thereunder expire on a date determined by the committee. The shares subject to the option are allotted in approximately equal annual installments over a period of not less than one nor more than ten years from the date the option is granted, but not beyond the optionee's normal retirement date as defined in the corporation's pension plan.

The right of the employee to purchase shares subject to any accrued installment may be exercised in whole at any time or in part from time to time prior to the terminal date by written notice to the company.

The notice shall specify a time of delivery at least fifteen days after the notice unless an earlier time shall have been mutually agreed upon. Neither the employee nor any person entitled to exercise his rights in the event of his death shall have any of the rights of a share owner with respect to the shares subject to the option until the certificates for the shares have been issued. With certain exceptions, the option and all unexercised rights thereunder become null and void if the grantee ceases to be an employee of the company.

Section 1091 of the Code provides in part as follows:

(a) DISALLOWANCE OF LOSS DEDUCTION.-In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction for the loss shall be allowed under section 165(c)(2); * * *

The word `acquired' as used in the above-quoted section of the Code means acquired by purchase or by an exchange upon which the entire amount of the gain or loss was recognized by law, and comprehends cases where the taxpayer has entered into a contract or option within the 61-day period to acquire by purchase or by such exchange.

In Daniel N. Gutmann v. Commissioner , 38 B.T.A. 679, acquiescence, C.B. 1939-1, 15, the taxpayer surrendered to a corporation of which he was a stockholder, some of its stock in payment of his indebtedness to the corporation. Without knowledge of the taxpayer, the treasurer of the corporation inserted in the minutes of the directors' meeting which authorized the purchase, an option allowing the taxpayer to repurchase the same shares, an act not made known to the taxpayer nor ratified by the directors until three months later. The Board, in determining that the sale was not a `wash sale,' said:

* * * there is no attack on the ultimate validity of the option after it was ratified by the corporation's board of directors and made known to the petitioner. Its validity within 30 days after the surrender by petitioner of his stock in consideration of the cancellation of his indebtedness to the corporation is alone to be considered. * * *

* * * no contract in respect of the option existed between petitioner and the corporation before the option was ratified by the corporation's directors; or, if the option right be treated as a gift, and informal ratification could be assumed, that the gift was not completed until acceptance by the petitioner donee, a necessary requisite.

* * * petitioner had no knowledge of the proposed option until some time in September, more than two months after his surrender of his stock. * * * It would seem obvious therefore that he could not in any sense be said to have `entered into a contract or option' within the proscribed period.

Following the reasoning of the Board, had the option been ratified by the corporation's directors and the taxpayer notified of the granting of the option within 30 days after he surrendered the stock, the transaction would have constituted a wash sale and the loss sustained by the taxpayer would have been disallowed.

Therefore, for the purpose of section 1091 of the Code, an employee of a corporation, who under the terms of a restricted stock option plan is granted an option to purchase stock of the corporation, will be held to have entered into the option to acquire stock on the date on which the option is granted him.

The employee will be held, also, to have acquired the shares of stock pursuant to the option on the date on which the certificates for such shares of stock are issued. However, in any case where the shares of stock represented by a restricted stock option have resulted in the nondeductibility of a loss under the provisions of section 1091, such shares will not again result in the nondeductibility of a loss within the 61-day period of the issuance of the shares to the extent they have already been considered in determining the nondeductibility of a loss within the 61-day period of the granting of the option.

The above principles may be illustrated by the following examples:

Example (1). A , whose taxable year is the calendar year, on January 1, 1953, purchased 400 shares of the common stock of the M corporation at $120 per share. On January 1, 1955, the M corporation granted to A , an employee, a valid restricted stock option to purchase 300 shares of its common stock at $85 per share, such option to be exercised on or before January 1, 1960. The fair market value of the M corporation common stock on such date was $100 per share. The 300 shares of stock were issued to A on January 1, 1960, pursuant to his exercise of the option. On January 15, 1955, A sold at $105 per share 200 shares of the stock which he had purchased on January 1, 1953, and on January 15, 1960, he sold at $115 per share another 100 shares of such stock. Because of the provisions of section 1091, no loss from the sale of the 200 shares on January 15, 1955, nor from the sale of the 100 shares on January 15, 1960, is allowable as a deduction.

Example (2 ). Assume the facts to be the same as in example (1), except that A sold the entire 400 shares of stock which he had purchased on January 1, 1953, as follows: 300 shares on December 15, 1954, at $105 per share, and 100 shares on January 15, 1960, at $115 per share. Because of the provisions of section 1091, no loss is allowable as a deduction on the 300 shares sold on December 15, 1954. The loss on the 100 shares sold on January 15, 1960, is allowable as a deduction, to the extent permitted by section 1211, since the sale of the 300 shares granted by the option has already resulted in the nondeductibility of a loss.