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Section 422(a)(2)13 requires the taxpayer to be an employee
of the corporation granting the option at all times from the date
the option is granted until 3 months before the date of
exercise.14 Sec. 422(a)(2). If the taxpayer exercises his ISOs
more than 3 months after termination of employment from the
grantor corporation, section 83, not section 421, applies to the
transfer of stock. Secs. 421(a); 83(e)(1); sec. 1.83-7, Income
Tax Regs.
Section 83(a) provides in pertinent part that if property is
transferred to a taxpayer in connection with the performance of
services (e.g., stock transferred to a taxpayer upon the exercise
of a stock option), the excess of the fair market value of the
stock (measured as of the first time the taxpayer’s rights in the
stock are transferable or are not subject to a substantial risk
of forfeiture) over the amount, if any, paid for the stock (the
exercise price) shall be included in the taxpayer’s gross income
in the first taxable year in which the taxpayer’s rights in the
stock are transferable or are not subject to a substantial risk
13 Sec. 422(a)(1) is not at issue.
14 The taxpayer may also be a employee of a parent or
subsidiary corporation of the corporation granting the stock
option, or a corporation or a parent or subsidiary corporation of
such corporation issuing or assuming a stock option in a
transaction to which sec. 424(a) applies. Sec. 422(a)(2).
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