Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

Attribution from Options Granted by Corporation

(Posted February 26, 1999)

Question 7: I'm not sure if this comes within the scope of your column but I'll ask the question anyway. My concern relates to the proper treatment of stock options where the options are granted on shares that are not outstanding. Are such options counted for the purposes of determining ownership under 414(q) and 416?
Answer: This does fall within my scope, because status as a 5% owner under 416(i) (and hence 414(q)) is determined under IRC 318, the exact same rules as are used to determine affiliated service groups.

I assume you are referring to an option granted by the corporation itself, promising to issue the shares if the option is exercised. Yes, that is a valid option, and the individual is treated as owning the shares as though they were issued. Let's look for a moment at what that means.

Suppose the latest Internet darling, eOptions, gives me an option to by 5001 shares of their stock at $30/share. The stock is currently trading at $20/share (but that will change in 5 minutes). At the moment, there are 100,000 shares outstanding.

I am treated as owning the stock. Of course, if I owned it, there would be 105,001 shares outstanding. So, I am deemed to own 4.76% of the stock of the company -- not enough to make me a 5% owner. However, if I had an option to buy 5300 shares, then I would be deemed to own 5.03% of the stock and to be a 5% owner.

Notice that it is irrelevant for purposes of IRC 318 that the current price is less than the option price.

Option attribution is discussed at length, including special pitfalls in connection with controlled groups, at Q 7:4 - 8 of my book, Who's the Employer?.

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