SECTION 2. BACKGROUND

Rev. Proc. 2002–13 provides a methodology for valuing stock options for purposes of §§ 280G and 4999. Stock options must be valued for purposes of §§ 280G and 4999 when a payment in the nature of compensation involves a stock option, such as when the grant of the option is a payment in the nature of compensation contingent on a change in ownership or control or, with respect to an option previously granted to the taxpayer, when the option becomes substantially vested within the meaning of § 1.83–3(b) and (j) as a result of the change in ownership or control. Rev. Proc. 2002–13 does not apply for purposes of valuing a payment in cash, even though the cash is determined by reference to the cancellation of a stock option.

Generally, Rev. Proc. 2002–13 provides that a taxpayer may value a stock option using any valuation method that is consistent with generally accepted accounting principles (such as Statement of Financial Accounting Standards No. 123 (Fin. Accounting Standards Bd. 1995 (FAS 123)) and that takes into account the factors provided in § 1.280G–1 of the Proposed Income Tax Regulations, Q&A13, published in the Federal Register on February 20, 2002 (REG–209114–90,

2002–27 I.R.B. 40 July 8, 2002

2002–9 I.R.B. 576 [67 F.R. 7630]) (the 2002 proposed regulations) and on May 5, 1989 (PS–217–84, 1989–1 C.B. 1038

[54 F.R. 19390]) (the 1989 proposed regulations). In addition, section 4 of Rev. Proc. 2002–13 provides a valuation method based on the Black-Scholes model.

Rev. Proc. 2002–13 provides that, if the stock option is one that could otherwise be valued under Rev. Proc. 98–34, 1998–1 C.B. 983, because the stock option is a “Compensatory Stock Option,” as defined in section 3 of Rev. Proc. 98–34 ( i.e., a nonpublicly traded option for stock that is publicly traded on an established securities market), then, for purposes of §§ 280G and 4999 and Rev. Proc. 2002–13, the valuation is not considered consistent with generally accepted accounting principles unless the valuation is made in accordance with Rev. Proc. 98–34 or the valuation safe harbor method described in section 4 of Rev. Proc. 2002–13.

Rev. Proc. 98–34 provides a methodology for valuation of certain compensatory stock options for purposes of gift, estate, and generation-skipping transfer taxes. The methodology described in Rev. Proc. 98–34 is an option pricing model that takes into account factors similar to those established in FAS 123. This methodology applies only to the valuation of a nonpublicly traded compensatory stock option for stock that, on the valuation date, is publicly traded on an established securities market.

Since the issuance of Rev. Proc. 2002– 13, commentators have suggested that the two valuation methods available for Compensatory Stock Options do not adequately take into account all of the facts and circumstances relevant to the valuation of Compensatory Stock Options in the context of a change in ownership or control. Commentators have also requested an extension of the effective date provided in Rev. Proc. 2002–13, or a modification of Rev. Proc. 2002–13 to establish a safe harbor for Compensatory Stock Options, to provide opportunity for consideration of comments.