rr-98-21.pdf

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# Part I

Section 2511 .-- Transfers in General

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

## 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 § 421 of the Internal Revenue Code) by the optionee to a
family member, for no consideration, a completed gift under
§ 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

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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

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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 § 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

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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

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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 § 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 $ 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.

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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) .