Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 71-40

1971-1 C.B. 135

Sec. 422

Sec. 425

IRS Headnote

An optionee's election to deliver a promissory note in payment for stock acquired upon exercise of a qualified stock option is not a "modification" under section 425(h)(3) of the Code where the terms of the option initially provided the election.

Full Text

Rev. Rul. 71-40

Advice has been requested whether a "modification" under section 425(h)(3) of the Internal Revenue Code of 1954 occurs when a promissory note is given in payment for stock acquired upon exercise of a qualified stock option under the circumstances described below.

The taxpayer was granted a qualified stock option within the meaning of section 422(b) of the Code. The option was granted pursuant to a plan the provisions of which require that payments for stock issued upon exercise of options granted under the plan are to be made in cash unless, at the discretion of the board of directors, the terms of an option at the time of grant allow an optionee an election to purchase shares by delivering his promissory note rather than cash. The terms of the option granted to the instant taxpayer permitted this election, and the taxpayer, upon exercise of his option, delivered his five year, five percent interest bearing promissory note in payment for the stock.

Section 425(h)(1) of the Code provides that if the terms of any option to purchase stock are modified, extended, or renewed, such modification, extension, or renewal shall be considered as the granting of a new option.

Section 425(h)(3) of the Code defines the term "modification" as meaning any change in the terms of the option that gives the employee additional benefits under the option.

Under section 1.425-1(e)(5)(i) of the Income Tax Regulations, a change in an option that provides more favorable terms for the payment for the stock purchased under the option is a modification.

Since the initial terms of the stock option granted to the taxpayer in this case provided for the payment of the stock under two methods, with the selection of the method of payment left to the discretion of the taxpayer at the time of exercise, there was no change in the option that would provide more favorable payment terms.

Accordingly, the taxpayer's delivery of the promissory note upon exercise of the qualified stock option was not a modification of the option within the meaning of section 425(h)(3) of the Code.