1% key employees and options

[Griswold]

Are options counted for purposes of determining key employees under the 1% owners prong?

 

The regulation says a 1% owner is any employee who owns “more than 1 percent of the value of the outstanding stock of the corporation or stock possessing more than 1 percent of the total combined voting power of all stock of the corporation.” Treas. Reg. §1.416-1 T-16.  Assuming the options don't have voting rights, to me this says you don't count options as they're not outstanding stock. Is there any authority that says otherwise?  Perhaps if the options are fully vested the employee might own 1 percent of the value?

 

[Belgarath]

If you have access to the EOB, there is a paragraph on this subject in the definition of "key employee." I think you would find it very helpful. But it basically agrees with your thinking on this. However, it also references an 83(b) election, and refers you to RR 2012-29 for guidance on 83(b) elections.

(Edited for typo)

[CuseFan]

I believe the provisions that require consideration of options say "who owns or is considered owning...."

Unvested options definitely do not count anyway as they are not yet exercisable.

[Bob the Swimmer]

Agree with Belgarath and CuseFan, an option is only an unexercised opportunity to own.

[Luke Bailey]

I think this is an instance where common sense does not prevail. Section 416 uses the 318 attribution rules. See IRC sec. 416(i)(1)(B)(I) and Treas. Reg. 1.416-1, Q&A T-16. IRC sec. 318(a)(4) says to treat an option as equivalent to ownership. See also Treas. Reg. sec. 1.318-1. My recollection is that there is at least one PLR that says you don't count an option until it is vested, i.e., has become exercisable.

[EBECatty]

There's also a good discussion of this topic in Who's the Employer reaching a similar conclusion based on Rev. Rul. 89-64 and PLR 200036027.

[CuseFan]

17 hours ago, Luke Bailey said:

Section 416 uses the 318 attribution rules.

That is the key - good call Luke. I would have expected the plan language to say "... or is considered owning..." so this is a trap (as Admiral Akbar would say) for the unwary. Regardless, as all noted, options must be exercisable (vested) to be considered ownership. 

These are the types of Q&A's that provide the best value in this forum, in my opinion, getting input from very smart people (such as Luke) on issues that can't be discerned simply by reading the document (which some do last rather than first based on other Q&A's we see).

[acm_acm]

On 3/7/2022 at 11:09 PM, Luke Bailey said:

I think this is an instance where common sense does not prevail. Section 416 uses the 318 attribution rules. See IRC sec. 416(i)(1)(B)(I) and Treas. Reg. 1.416-1, Q&A T-16. IRC sec. 318(a)(4) says to treat an option as equivalent to ownership. See also Treas. Reg. sec. 1.318-1. My recollection is that there is at least one PLR that says you don't count an option until it is vested, i.e., has become exercisable.

I also think that options can make it so that more than one person can waive their benefit under PBGC rules in a standard termination.

[Luke Bailey]

4 hours ago, acm_acm said:

I also think that options can make it so that more than one person can waive their benefit under PBGC rules in a standard termination.

I haven't checked this, acm_acm, but if it comes up in the future I'll check it out. Good to have in mind. Thanks.