[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.83-7]

[Page 342-343]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.83-7  Taxation of nonqualified stock options.

    (a) In general. If there is granted to an employee or independent 
contractor (or beneficiary thereof) in connection with the performance 
of services, an option to which section 421 (relating generally to 
certain qualified and other options) does not apply, section 83(a) shall 
apply to such grant if the option has a readily ascertainable fair 
market value (determined in accordance with paragraph (b) of this 
section) at the time the option is granted. The person who performed 
such services realizes compensation upon such grant at the time and in 
the amount determined under section 83(a). If section 83(a) does not 
apply to the grant of such an option because the option does not have a 
readily ascertainable fair market value at the time of grant, sections 
83(a) and 83(b) shall apply at the time the option is exercised or 
otherwise disposed of, even though the fair market value of such option 
may have become readily ascertainable before such time. If the option is 
exercised, sections 83(a) and 83(b) apply to the transfer of property 
pursuant to such exercise, and the employee or independent contractor 
realizes compensation upon such transfer at the time and in the amount 
determined under section 83(a) or 83(b). If the option is sold or 
otherwise disposed of in an arm's length transaction, sections 83(a) and 
83(b) apply to the transfer of money or other property received in the 
same manner as sections 83(a) and 83(b) would have applied to the 
transfer of property pursuant to an exercise of the option.
    (b) Readily ascertainable defined--(1) Actively traded on an 
established market. Options have a value at the time they are granted, 
but that value is ordinarily not readily ascertainable unless the option 
is actively traded on an established market. If an option is actively 
traded on an established market, the fair market value of such option is 
readily ascertainable for purposes of this section by applying the rules 
of valuation set forth in Sec. 20.2031-2.
    (2) Not actively traded on an established market. When an option is 
not actively traded on an established market, it does not have a readily 
ascertainable fair market value unless its fair market value can 
otherwise be measured with reasonable accuracy. For purposes of this 
section, if an option is not actively traded on an established market, 
the option does not have a readily ascertainable fair market value when 
granted unless the taxpayer can show that all of the following 
conditions exist:
    (i) The option is transferable by the optionee;
    (ii) The option is exerciseable immediately in full by the optionee;

[[Page 343]]

    (iii) The option or the property subject to the option is not 
subject to any restriction or condition (other than a lien or other 
condition to secure the payment of the purchase price) which has a 
significant effect upon the fair market value of the option; and
    (iv) The fair market value of the option privilege is readily 
ascertainable in accordance with paragraph (b)(3) of this section.
    (3) Option privilege. The option privilege in the case of an option 
to buy is the opportunity to benefit during the option's exercise period 
from any increase in the value of property subject to the option during 
such period, without risking any capital. Similarly, the option 
privilege in the case of an option to sell is the opportunity to benefit 
during the exercise period from a decrease in the value of property 
subject to the option. For example, if at some time during the exercise 
period of an option to buy, the fair market value of the property 
subject to the option is greater than the option's exercise price, a 
profit may be realized by exercising the option and immediately selling 
the property so acquired for its higher fair market value. Irrespective 
of whether any such gain may be realized immediately at the time an 
option is granted, the fair market value of an option to buy includes 
the value of the right to benefit from any future increase in the value 
of the property subject to the option (relative to the option exercise 
price), without risking any capital. Therefore, the fair market value of 
an option is not merely the difference that may exist at a particular 
time between the option's exercise price and the value of the property 
subject to the option, but also includes the value of the option 
privilege for the remainder of the exercise period. Accordingly, for 
purposes of this section, in determining whether the fair market value 
of an option is readily ascertainable, it is necessary to consider 
whether the value of the entire option privilege can be measured with 
reasonable accuracy. In determining whether the value of the option 
privilege is readily ascertainable, and in determining the amount of 
such value when such value is readily ascertainable, it is necessary to 
consider--
    (i) Whether the value of the property subject to the option can be 
ascertained;
    (ii) The probability of any ascertainable value of such property 
increasing or decreasing; and
    (iii) The length of the period during which the option can be 
exercised.
    (c) Reporting requirements. [Reserved]
    (d) Effective dates. This section applies for periods before July 2, 
2003. For periods on or after July 2, 2003, see Sec. 1.83-7T.

[T.D. 7554, 43 FR 31920, July 24, 1978, as amended by T.D. 9067, 68 FR 
39454, July 2, 2003]